Marco Polo Marine: Drilling for higher income.

I am going to take another trip down memory lane and this time to look at why did I invest in Marco Polo Marine. Then, I will look at the most recent development in the business.

I first invested in Marco Polo Marine in the middle of 2012 when I spotted persistent insider buying. I got in at 31.5c and 32c a share. Since then, I have been accumulating. The highest price I paid was 42c a share and the last time I bought more of its stock was on 24 June 2013 at 37.5c a share.

The combination of a few factors gave me the conviction to make Marco Polo Marine the largest investment in my portfolio:

1. Insider buying.
2. Chairman of the company has close to 60% stake.
3. A relatively consistent ROE of about 15%.
4. Timely emphasis on building a fleet of AHTS vessels.
5. Enforcement of cabotage laws in Indonesia.
6. Relatively cheaper valuation compared to peers.

A complaint I had was that it was moving too slowly and I wished that it would leverage up and buy OSVs to immediately take greater advantage of the higher charter rates in Indonesian waters.

In the current climate, it is hard to buy OSVs at what might be considered good prices and it is not difficult to understand why. So, Marco Polo Marine would rather build OSVs in their own shipyard than to buy from others. However, they did manage to get a good price for MP Prevail last year. I think that shows that the management is rather savvy when it comes to acquisitions.

With their gearing level on the rise, however, I was rather concerned about the strength of their balance sheet but if the business chugs along with the progressive deliveries of the OSVs being built in their shipyard, we should see progressively stronger earnings in the next couple of years, everything else remaining equal.

Of course, we now know that everything else did not remain equal because Marco Polo Marine issued some MTN and decided to buy a jack up rig. This was totally beyond my expectations and it took me a while to digest the news.

My initial reaction was to ask how Marco Polo Marine, a company with a market capitalisation of S$135 million, was going to pay for a US$214 million rig? That was a natural reaction. However, when we think of the S$300 million MTN they have in place, it all makes sense.

Marco Polo Marine drew down S$50 million in MTN in the last quarter and this attracts some S$0.7 million in finance cost every quarter. As they only have to pay 10% of the rig's total bill this year, I have an inkling that they might use the remaining money to pay down debt. They only have to pay another 10% of the rig's total bill by 11 February 2015. The balance 80%, they only pay when they take delivery of the rig in 4Q 2015.

What this means is that we could see lower profit this year. However, if some debt is paid down and if the two 8,080 BHP AHTS vessels are completed on time, we could see the impact lessened. Assuming the status quo, then annualising 1Q 2014's numbers, we could see a 22% reduction in EPS to approximately 4c or so, year on year. This assumption is, of course, unrealistic, and would form my worst case scenario for the company.

The cabotage law in Indonesia will include drilling rigs by December 2015 and to time the delivery of the rig in 4Q 2015 really makes sense. There is no need for a huge capital outlay in the meantime while Marco Polo Marine sees more own built OSVs joining its fleet in the next two years which should improve earnings as the vessels enjoy higher charter rates.

When the time comes to take delivery of the rig, Marco Polo Marine should be financially more robust but it would still need to draw from its S$300 million MTN program to pay for the rig. This is the hard truth but it is good to know that financing is in place.

Chances are high that Marco Polo Marine will be able to secure a contract for the rig a few months before they take delivery of it. Chances are also high they will be able to get pretty good rates as there is a lack of such high specs rigs in Indonesia and, of course, the enforcement of cabotage law in the country for rigs by then tilts the scales in Marco Polo Marine's favour.

Now, how significant an income contributor could the rig be?

According to AM Fraser, the Pacific Class 400 jack up rig which Marco Polo Marine ordered commands a day rate of some US$ 160,000 in Thailand. With the cabotage law in Indonesia, the rate could be higher when Marco Polo Marine takes delivery of their rig end of next year. I know that AHTS vessels enjoy a 20 to 30% premium in Indonesian waters. Could we expect the same kind of premium for rigs come December 2015?

If we were to do some quick mental sums, we would be able to conclude that this is probably going to be a very good investment. Simplistically, just putting the rig to work 11 months in a year could bring in some serious money without factoring in any possible premium. In such an instance, the return on the investment would quite easily exceed the 5.75% coupon payable on the MTN.

So, my assessment of this latest development is that it will lead to some short term earnings depression due to higher finance costs but it is not going to cause the company any distress. By 2H 2014, things would start to look up and by 2015, with more AHTS vessels in its fleet, enjoying higher charter rates, earnings would look even better. Then, when the rig is delivered by end of 2015, we should see a big boost to earnings, if everything goes as planned.

Do we share Sean Lee's vision and are we able to take the same leap of faith? Or do we think he has a few loose screws in his head?

Related posts:
1. Marco Polo Marine: Exciting times ahead.
2. Marco Polo Marine, Mermaid Maritime and Jaya Holdings.

Sabana REIT: Buy but remember the Sukuk.

In November 2013, I said that I reduced my investment in Sabana REIT and moved the funds into Croesus Retail Trust, believing that a reduction in my exposure to industrial properties in Singapore was sensible. At the time, Sabana REIT was trading at about $1.09 a unit.

Then, in January 2014, I wrote a piece saying that Sabana REIT's quarterly results were within my expectations and that trading at $1.07 a unit, we could see its unit price fall to $1.03 once the REIT went XD if Mr. Market were to demand a 2% premium over the market leader, A-REIT.

I also said that although I was not buying at $1.07, neither was I selling. The reason was because Sabana REIT's relatively low occupancy of 91.2% could improve over time. So, we could see DPU and distribution yield improving, everything else remaining equal.

How much of an improvement would we see? Well, assuming that Sabana REIT improved occupancy of its properties to 96% and that DPU improved proportionally, we could see an annualised DPU of 9.2c. This would give us a yield of some 8.6% at its NAV of $1.07 a unit.

At a price of $1.03 per unit, we are just a whisker away from a 9% yield. It would be 8.93%. This is rather attractive and at $1.02 a unit, we see a prospective distribution yield of 9.02%. $1.02 a unit also coincides with a technical support provided by Fibo retracement lines.

So, it is not surprising to see investors buying again at current prices even though, technically, I see a stronger support at 97.5c or 98c a unit. Do I really think unit price could go that low? This is just what I see in the chart as a possibility. I don't know if it would happen.

However, remember the $80 million Convertible Sukuk due on 24 September 2017? In 2012, when I blogged about this, I said that if all should be converted to new units in the REIT, they would add some 10.5% to all units in issue. This would dilute existing stakeholders' interests but the debt would disappear.

"During the financial year ended 31 December 2013, certain Converting Sukukholders had converted an aggregate principal amount of $7.5 million. As a result, the Group elected to issue 6,285,090 units at the then conversion price of $1.1933 to these Converting Sukukholders."
Source: Full year 2013 report.

The bond holders pay a higher than market price and the REIT's gearing level declines at the same time. Seems like a good deal for the REIT. Actually, it makes sense to the bondholders too as they are paid a coupon of only 4.5%. Even converting to units at $1.1933 would mean enjoying a distribution yield of some 7.3%. Of course, this is leveraged yield. So, not really comparable.

Anyway, we should not worry about what these bond holders should do. Instead, we should think about how would their actions impact us as investors in the REIT.

If all the bond holders should convert to units by 2017, be prepared for a further 8.8% dilution but the REIT's gearing would then decline to a lower 33% thereabouts. Is this a good thing?

Well, it would mean that any increase in DPU from improving occupancy level could be diluted and we might not see much of a difference from current levels. If there should be zero improvement in occupancy level, which I think unlikely, then, we could see DPU reducing to 8.08c which means a yield of 7.84% at a unit price of $1.03 which makes a unit price of 98c a unit seems less far fetched.

Of course, if the convertible bond holders decide not to convert to units anymore and wait for maturity in September 2017, then, expect the status quo, everything else remaining equal.

What the bond holders would do is anyone's guess but what are investors in the REIT to do? Well, add to long positions at $1.02 to $1.03 a unit if we like but bear in mind the convertible bond and the possible effects. Are we comfortable with it?

In my opinion, prices of $1.02 and $1.03 a unit are not bad but don't be surprised if unit price should decline to 98c. So, always have a war chest ready.

Related posts:
1. Sabana REIT: Convertible Sukuk.
2. Added Croesus Retail Trust and reduced Sabana REIT.
3. Sabana REIT: After the 4Q 2013 results, am I buying or selling?