Ezra @ 2.50 ( Offshore support / Singapore ) 0 comments

Final Poll Results: 5:2

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Main issues

1.One-time items in P&L

2. Long-term lease off-balance sheet

This is one of those stocks that I have been hesitant on covering in this blog for some time, for the main reason that it is providing direct support in a sector that I believe is on a multi-year uptrend: oil and gas exploration in Southeast-Asia. Yet with no discernible strong growth in recurring earnings padded further by what I see as increasing unrecognised balance sheet risk, seemingly ignored by the market in its inexorable share price rise, has convinced me to include it as a hot-stock-not.

One thing that should immediately be clear to even casual observers of this stock is that its strong profit growth these 2-3 years has been mainly due to well-timed vessel/securities disposals as below:
- $5.5M out of $8.2M pre-tax profit in 1H04 (without which there would have been little earnings growth)
- $6.5M out of $9.8M pre-tax profit in 1H05 (hence outperforming 1H04 exceptional gains)
- $22M out of $38M pre-tax profit in FY05 (due to securities valuation mark-up; taking away "other operating income" for both FY04 and FY05, earnings growth would have been only ~20%)
- $25M out of $35M pre-tax profit in 1H06, plus another $7M from associates and JVs; taking away "other operating income" for both 1H05 and 1H06, operational profit would have been stagnant

For those PE-inclined investors, stripping away all "other operating income" for FY05 and taking into account the 1:5 bonus in June 06, Ezra's trailing PE comes up to a whopping 36X.

That is surely a high price to pay for any company, even one in a hot sector. Ezra undoubtedly has been positioning itself well for the coming offshore support boom, but would you buy into them without an idea of how industry-wide supply of offshore support vessels has been growing? Surely others have been building new vessels as well?

The strength of Ezra has been its aggression in expanding its fleet, having doubled its fleet of mainly AHTS vessels to ~30 vessels through continuous ordering of new vessels through 2004-06. I also quite like their capital management where they have been financing expansion with a combination of debt, share placements and sales-and-leasebacks. However it may be worth noting their liability exposure, in particular the off-balance-sheet kind.

Consider the AHTS sales-and-leaseback deals. Since early 2005, Ezra has arranged two sales-and-leaseback deals covering 13 AHTS vessels which it had ordered, in order to release capital for further expansion. These two sales-and-leasebacks add up to US$260M or ~S$400M, and if we treat these as capital leases and insert them into the balance sheet things would look rather bad in the Liabilities column (of course, there would be a corresponding entry in the Assets column as well), given that Ezra's current NTA is ~S$170M.

Firstly, the exposure through long-term leases is huge.... here I am assuming that the value of the leasebacks is equal to the disposal sum; secondly, the value of the long-term lease liability is cast in stone while the the value of the assets (the right to use the vessels through the lease) could change. What I mean is that Ezra is locked into long-term leases for these new vessels based on buoyant market conditions and this might be risky given the value of these leases relative to its asset backing and potential volatility in the vessel chartering industry (we have all seen how the container ships and bulker chartering rates have floundered due to looming oversupply --- despite continuing buoyant world trade). The crucial issue is for Ezra to secure good long-term charters on it's customers' side. Since 2005 it has secured ~US$120M, or S$190M, worth of charters for its AHTS vessels, but that is for its entire current fleet of ~30 vessels. Compare that with the abovementioned leaseback deals that it is committed to and one has to sweat over Ezra's continuing ability to secure more chartering deals for its expanded fleet.

The execution risk for this company is immense, as is always when there is rapid expansion. It may be worth noting that the founding Lee family had been trimming their stake over 2005, as well as substantial shareholder KS Tech; both companies had been unwinding their cross-holdings. An area of promise, which might have fired up investors' imagination, had been cooperation between the two companies to own and charter offshore rigs; the incentive now seems less given the reduced shareholdings in each other, as well as Kris Wiluan's takeover of KS Tech implying a whole new paradigm in top-level relationships and potential partnership dealmaking.