Saturday 28 March 2020

My View On What Causes Market Crashes

Many Stock Market indexes have now rebounded approximately 20% from their lows. Now market spectators are divided- some say this is a technical rebound and the bottom has not arrived; while another group says the Monday close was the bottom and we are out of the woods.

I will weigh in my thoughts on market bottoms, based on what I observed of the GFC 2008-2009

GFC 2008-2009 Bottom - 2 Bankruptcies in 2 Industries

There were two events that triggered US markets to crash each time. I will be basing on the Dow Jones Index Performance as a reference.

The first was the collapse of Lehman in late Sept 2008. This resulted in the Dow crashing from its 11,000 point level. The crash happened for a period of market days and the Dow only stated to range bound when TARP was officially implemented in Oct 2008. The Dow remained at the 7000-8000 levels for the rest of the year after this. However, this did not spell the end of the market crash.

The second event was the collapse of the US automakers where a bailout was announced in Dec 2008 and was finally implemented in March 2008. Again the Dow crashed over a 2 months period and only stopped its decline when the US government officially took control of GM and Chrysler in March 2008. The second event caused the Dow to fall from the 8700 levels to the 6500 mark.

From these 2 events, my view is that it takes the entire implementation of a policy before markets will regain normalcy. And if there is a bankruptcy in another industry, markets will collapse and only stabilise when the subject industry stabilises.

Back to 2020

By now, we know the collapse of airlines have been starved off with countries providing credit lines to their airlines. For our markets to resume normalcy, the proposed legislations have to be implemented. As of now, US has signed its legislation but has not put it into place yet. 

Hence one may expect things to be volatile for the next few months until the official implementation. After that, the next order of thinking is if there are any more industries that are poised for bankruptcy. 

Saturday 14 March 2020

What Low Oil Price Environment Means to Investing?

It has been one week since the Saudi and Russia disagreed in their production cuts. The week long price movement in WTI Crude and Brent gives an indication of where prices will be in the year or so.

To me, it seems WTI will trade in the band of US$30-40, while Brent will trade in the band of US$35-$45. It is at this junction one will wonder how they can position themselves in their oil investments

Four Main Ways to Extract Oil

There are 4 ways to extract way: I) Onshore (land) drilling, ii) Extracting Oil from shallow Water wells (less than 150 metres), iii) Deep water oil wells and iv) Shale Oil.

Each method has their own breakeven cost. Onshore land drilling is the cheapest where the Saudis are extracting oil at a single digit per barrel, the Russians are extracting oil in the USD$10-$20 range. This means at current levels, it is still cashflow positive for many onshore drillers to extract oil. Do note, I am looking at the cost of extracting oil, there are other cost items to look out for such as corporate overheads etc which is why there are news that says "Russia need $40 oil per barrel to break even/balance their budget" etc.

For me I am looking at purely the cost of extracting oil which will affect the immediate businesses supplying to the 4 different oil extraction Segments. Their is another cost analysis people look at which is the total breakeven cost, this affects their decision to intiate a new oil well or otherwise. For shallow water, deep water and shale, such breakeven cost tend to be US$50-US$70 per barrel. This means it is unlikely we will see new oil projects coming in.

How much it cost for Shallow Water Drillers and others?

Moving on, the cost of extracting shallow oil is unknown to many of us; fortunately, there is one listed Shallow Water Oil Producer company here- Krisenergy. Based on their corporate presentations, the cost of extracting oil ("Lifting cost:) in South East Asia shallow waters is US$20-25; it means shallow water oil operations is still cash flow profitable under current circumstances.

Deep Water drilling cost is about US$25-40, while Shale is US$25-60, the US Permian basin has one of the cheapest extraction for shale oil but its the only one, the rest are in the range of US$30-50s.

Seen in this light, at current oil prices, it is definite shale oil is not profitable to extract and companies will not be adding new shale oil wells (Shale oil companies need about US$50-60 to justify drilling new shale wells). My view is that Shale Oil will fail in the next 2 years.

How it Affects SGX Companies

There are only a handful of companies that has exposure to shale such as CSE Global. At current low oil prices, CSE is going to see a fall in revenue especially when the US segment is one of its largest revenue.

The other SGX companies tend to service the shallow oil producers. Examples are Nam Cheong, Penguin Holdings, Marco Polo Marine, MTQ (MTQ services companies across the 4 extraction segments). While shallow water oil producers extract oil at a much lower cost, the lower oil prices will affect their revenue and they will try to ask for lower quotations from the mentioned companies for the services they provide.

Sembcorp Marine and Keppel Corp services the deep water and shallow oil segment where the profitable contracts tend to be deep water oil rigs. It is likely with such low oil prices, Sembcorp Marine and Keppel will see very little new orders. They will have to rely on refurbishing ships to sustain their yard operations.

However as we progress through this oil crisis, it is likely shallow oil producers will emerge from the woods first. This is due to their lower cost base

My rough gauge is that Shallow Oil needs US$50-US$55 per barrel to breakeven from all costs they have.  

How Long will the Oil Price War Continue?

In my opinion, this can go on for a long time. Saudi Arabia and Russia carry very little debts. So if they continue to sell oil at below their budget breakeven, they can resort to taking on more debts at cheap rates. They have to be thankful for the QE by the 3 main reserve banks (US Fed, ECB, Bank of Japan).

Shale oil producers will not last long because they are already in a state where they have taken a lot of debt and are struggling to repay their debts even at these low interest rates. Russia and Saudi Arabia can move to the phase of taking more debts and with their low oil extraction rates, they can easily service the low interest on their newly issued debts.

In 2021 and 2022, we will likely see shale oil being almost wiped out and at that junction, I believe Oil will then move on to $40-50 range. I do not think Oil will go back to above US$70 for a long time because this makes it profitable to drill new shale oil wells. 

Tuesday 10 March 2020

FTS International (NYSE; FTSI)- Hydralic Fracking Solution Company with No Turnaround soon

This is my first foray into evaluating a company outside of Singapore. This company was brought to my attention in a forum and because the format it reports its financials are similar to how Singapore companies report here; likely because its institutional shareholders are Singaporean linked companies, I was able to analyse the company easily.

Background of FTS International (FTSI)

FTSI is in the USA Fracking Industry. Its main business is the leasing of fracking units to oil exploration and production companies in the US Shale Oil industry (also known as Fracking). Their model is similar to rig companies who own the rigs and leases these rigs to oil exploration companies who are extracting oil in the sea.

FTSI financials can be found in this link, under "Current report filing" dated 12 Feb 2020. The group has only two full years of financial results because it IPO'd in 2018 to raise funds for its operations.

Will it be Able to Repay its Debts?

As of writing, the company is trading at a range of US$0.40-US$0.50 per share. It made a loss of US$72.6 million or US$0.67 loss per share in 2019. It is now selling at a book value of 1.45 times. Quite an expensive valuation in my view.

What is interesting is its debt profile and cashflow generation ability. FTSI has two tranches of debt:

(A) Term Loan Due in April 2021 of US $90 million
(B) Senior Notes (Bonds) due in May 2022 of $369.9 million

Its cash profile is as follows:

(A) Cash Reserves of US$223 million, of which it needs only about US$100+ million to run its business (a Q&A asked during the presentation of financial results by FTSI management), indicating an excess of US$100million in excess cash.

Weakening Fundamentals of US Shale Oil 

One of the biggest news that happened this week was the disagreement between Saudi Arabia and Russia in maintaining oil prices. This resulted in oil prices falling to the US$30 per barrel range which was last seen in 2015-2016.

For the past 2 years, FTSI had been operating in an oil environment where WTI price was in the US$50-70 range. If one observes the free cash flow generated by FTSI in those 2 years, one can notice a pattern: In 2019 when WTI was at a US$50-60 range, FTSI produced $26 million from the leasing of its fracking units. In 2018, when WTI was in the range of US$60-70, FTSI produced about US$280 million in free cashflow. See Page 6 of the financial report in the Link

If WTI is to stay in its range of US$30+ to US$50 range over the next 2 years, we can perhaps say that FTSI will be producing very little free cash flow for its business. Furthermore, the current low prices means US frackers will definitely reduce their drilling activities in the USA. Furthermore, some fracking oil E&P US companies are poised for bankruptcy under current oil conditions. All these point to a fall in demand for FTSI fracking units.

As mentioned, FTSI is definitely able to repay its 2021 term loan due to its cash pile, however I doubt FTSI will be able to redeem fully its 2022 bonds, especially when capital markets are now less welcoming to the energy sector. In the market, FTSI bonds are currently selling below the 70 cents range which indicates distressed levels.

Furthermore, with US fracking industry poised to decline, there is going to be an oversupply of fracking units in the market.

Expected Value of FTSI

The weakening of US shale raises the question if FTSI will be able to roll over its debts in 2022. Until WTI moves to above US$50, it is prudent to value FTSI at a book value of between 0.25 to 0.50 times its book value, to indicate some form of distress. This points to a US$10-US$20 million market cap or US$0.10-US$0.20 range

Saturday 7 March 2020

Sembcorp Marine- No end in Sight and Possible Privatisation Target?

Just when we thought the oil and gas downturn is over, it seems the night just got darker. Sembcorp Marine, one of the bellwether company, posted a higher year on year losses. Loss per share was at 6.5 cents per share. Sembcorp marine's financial results can be found here.

Here are two insights into the company:

1) Construction of Rigs and other offshore vessels is still weak

This is the main business of Sembcorp Marine and is found in Pg 21 and 22 of the financial report. As observed, revenue in this segment has fallen along with a wider loss. That said, revenue recognition for such business is lumpy and it could be that in 2018, SembCorp Marine recognised a larger portion of its projects. Hence we turn our attention to Sembcorp Marine's order book. It is seen that the company has not replenished its orderbook and it has fallen from 3.1Billion to 2.4 Billion as of end 2019. It means Sembcorp is not getting enough orders to replace the older projects it is completing or completed

A lack of orderbook mean significantly lesser revenue will be recognised in the near term. With fixed overheads to cover, it is likely Sembcorp Marine is going to post another financial loss for FY2020.

2) Weak Cashflow

This can be seen in Pg 11 of the report. Operating cash flow before working capital changes was a positive $103 million. Sembcorp is paying $108 million for interest on its loan and receiving about $68 million from dividends and finance sources. Furthermore with the need to pay about $300 million to maintain its plant and equipment, the conclusion is that the current business is in a net cash outflow situation. With $380 million in cash reserves left, its going to be tough on Sembcorp Marine

Possible Privatisation Play

Given the large fall in share price and weak fundamentals, my opinion and possibly the market's as well is that there may be plans to consolidate Keppel Marine and SembCorp Marine into one entity to reap cost savings.

Sembcorp Marine is struggling on its own and with our sovereign wealth funds not coming in to act as a back stopper; if no merger is going to happen, it is likely Sembcorp Marine will sink.

Hence how much will Sembcorp Marine be privatised at?

To me, a price book of about 0.7 times is the likely number (this means 70 cents). This is because business condition in the oil and gas is still deteriorating and we are right now in a monetary easing scenario with QE and close to negative interest rates, yet Sembcorp Marine is struggling!

Hence the acquirer is likely to only buy where there is a significant discount to its current book value of $1.03 per share which is set to decline again this financial year.