Ezion Holdings - Maybank Kim Eng 2016-08-24: Understanding its cashflows

Ezion Holdings (EZI SP) - Maybank Kim Eng 2016-08-24: Understanding its cashflows EZION HOLDINGS LIMITED 5ME.SI

Ezion Holdings (EZI SP) - Understanding its cashflows

    May need refinancing from FY18 

    • We evaluate Ezion’s cashflows to gauge its ability to weather a downturn in a tightened credit market. 
    • Our analysis suggests that risks are relatively low for FY16 and FY17, but it may need refinancing of c.USD270m over FY18-FY20. But this amount may be lower or unnecessary if it restructures its loans, which it is in the process of doing. 
    • Even if funding is needed, it would be beneficial for banks to do so to preserve and recover their loans. 
    • Maintain BUY and SGD0.45 TP, still on GGM-based 0.5x FY17 diluted P/BV.

    Credit stress in the market 

    • Swiber’s fallout and KrisEnergy’s flagging of its debt woes have stoked fears of banks tightening credit for oil services players, which may affect their ability to refinance debt. This is a problem as many oil services players are significantly leveraged with net gearing typically between 0.6x to 1.6x. Ezion’s net gearing stood at 1.1x at 2Q16.
    • We forecast Ezion to turn from negative FCF to its first positive FCF year in FY16.
    • FCF generation could step up further in FY19 when all its expansion capex is done.
    • While we expect Ezion to generate positive FCFs over the next few years, its average yearly FCF would cover only about 10% of its net debt. This is the case even for big players like Keppel and Sembcorp Marine. For most players with leverage, it would be nearly impossible to survive if banks do not refinance their debt.
    • We do not think that banks will pull all their credit lines from all oil services players, but they would be more stringent in extending support. Credit cost would also rise. Logically, banks should support players that could still generate profits and positive cashflows as this would preserve their ability to recover their loans fully when the oil market recovers. Withdrawing credit and seizing assets would not help as banks do not have the capability to operate the oil & gas related assets, and they may have to sell them at severely depressed prices.
    • Companies that can keep the assets utilised will be able to extract more value than banks.

    Ezion’s financial liabilities 

    • We took a closer look at Ezion’s financial liabilities to understand its obligations and cashflow needs. Ezion has total bank debt of USD1.2b and also has SGD545m/USD390m of outstanding bonds as at FY15. At 2Q16, the figures were similar with bank debt of USD1.2b and bonds of USD398m.
      1. Bank debt – USD1.2b Based on available data, we mapped out its possible cashflow bank debt repayment schedule above. Over the next 5 years, debt repayment cashflows are in excess of USD200m per year.
      2. Bonds – USD390m We also looked at Ezion’s bond covenants. Ezion does not show any signs that it is close to breaching any of its covenants. For it to breach those metrics, there needs to be significant impairment of its assets which we deem as unlikely currently as it kitchen sinked USD81m of impairment in 4Q15 and the majority of its assets are utilised and generating cashflows.
      3. Trade receivables and payables – While its receivables have increased as clients take longer to pay, so did its payables as it takes longer to pay its suppliers. We assume that its receivables could at least match its cashflow requirements for payables.

    Cashflow analysis 1 – Maybank KE’s forecasts 

    • Given the fear of credit drying up, we analyse Ezion’s cashflows to understand how long it can sustain on its own cashflows before it may require refinancing/interim funding. To do this, we made the following assumptions:
      1. Maybank KE’s operating cashflow forecasts for FY16-18E.
      2. Flat EBITDA in FY19 and FY20 and EBITDA as a proxy to operating cashflows.
      3. Capex of USD100/180/180m for FY16/17/18E and 70% of these capex would be financed with new loans that Ezion had already secured.
      4. No more expansion capex after FY19E and only maintenance capex of USD25m/year. This would significantly bump up FCFs from FY19E.
    • Our analysis shows that Ezion could rely on its own cashflows to pay off its cash liabilities in FY16E and FY17E but may need some refinancing from FY18E in order to meet its obligations. We believe that it is possible for Ezion to take on new debt by then, as its gearing would have improved from 1.1x currently to about 0.7x by then as it would have paid off its debt.
    • But if Ezion extends its average loan repayment period from 5 years to 8 years, it could totally eliminate the need for refinancing. We understand that Ezion is indeed negotiating with banks to do so. We think that it is in the interest of banks to help Ezion so they can preserve and recover full amount of the loans.

    Limitations to our analysis 

    • There are limitations to our analysis as we have looked at Ezion’s cashflows on a consolidated group level. But in reality, cashflows and liabilities may be restricted to an individual subsidiary. We highlight some of the potential problems that may not show up in our consolidated cashflow analysis.
      1. Each of Ezion’s liftboat assets is in a separate subsidiary entity where its contractual cashflows and loans are likely ringfenced for a specific loan facility. Excess capital from one entity may not be easily transferred to meet the obligations of another entity. Banks that have their loans secured on it will likely not allow Ezion to do so.
      2. Ezion has ST bank debt of USD127m and USD111m of cash at the company level as at 2Q16. There would be inflow of USD100m of rights proceeds but Ezion has specifically said that this would not be used for debt payment purposes. We estimate that it may have USD20m cash from the recent asset disposal that could be used to meet its short-term liability. But on a longer term, if cashflows from operating assets are restricted from being repatriated to the company level, it may need a higher amount of re-financing from banks. But it has other options such as:
        • There are some assets which loans would have been paid off (units 1, 3, 5). Cashflows from these assets should be able to be repatriated to company level.
        • These same assets may be re-pledged to secure more loans.
        • These same assets may be sold in a worst case scenario for more immediate cashflows.
    • Admittedly, there are pockets of potential stresses that Ezion needs to address, but we do not think it is in such dire straits that the issues can’t be resolved.
    • In our view, if oil stays at least USD40-50/bbl, Ezion has a high chance of getting through the downturn. Liftboats offer a cost-efficient option for oil companies to service and maintain production at their offshore production platforms in this challenging environment. Our conviction will grow stronger when more of Ezion’s assets start contributing to cashflows from 4Q16, which we see as a key re-rating catalyst for the stock.
    • The downside to our view would be if oil price dips towards USD30-35/bbl, where offshore production becomes unprofitable. The risk of contract cancellations then becomes high and Ezion’s cashflows would be impeded. Banks will panic and may withhold credit lines. In the worst case scenario, if the downturn sustains till 2018, we cannot rule out the possibility that Ezion may need another round of equity funding.

    Cashflow analysis 2 – Consensus forecasts 

    • We run the same analysis using Bloomberg consensus EBITDA as a proxy to operating cashflows and consensus capex forecasts. 
    • Consensus numbers suggest that Ezion would not sink into a cash deficit until FY19E. Similarly, with restructuring of loans, Ezion could eliminate its need for any refinancing.

    Cashflow analysis 3 – No growth environment 

    • Lastly, we run the analysis assuming that there is no growth in EBITDA and it stays flat at USD200m from FY16-20E. In such a case, we expect Ezion to defer its capex further and have assumed that expansion capex over FY17-18E is spread over FY17-20E. In this case, Ezion would need to start refinancing its debts from FY17E.
    • Ezion’s bond yields at 8.4% vs 23-33% for weaker oil services players If we look at the bonds for Singapore O&M players, the market is pricing higherrisk small-cap oil services players’ (Pacific Radiance, Name Cheong and Ezra) bonds at 23-33% yield-to-maturity. Swiber’s bonds due 2017 were trading at 60 cents to the dollar with >90% yield prior to its liquidation announcements, while KrisEnergy’s 2017 and 2018 bonds are also trading at 62-67cts to the dollar with bond yields of 67% and 33% respectively.
    • Comparatively, the bond yields of Ezion, at an average 8.4%, is significantly lower and bond prices are still at >85 cts to the dollar, suggesting that the bond market does not doubt Ezion’s ability to repay its bonds. But they require a higher yield to compensate for the increased risks in the oil & gas sector as seen by the increased yields and widened credit spreads.

    TP of SGD0.45, pegged to 0.5x P/BV 

    • We value Ezion at 0.5x diluted P/BV, deriving a TP of SGD0.45. Our 0.5x P/BV target multiple is based on GGM, where we use average FY17-18E ROE of c.8.5% to represent its sustainable ROE and a cost of equity of 18% to price in the heightened credit risk and increased negative sentiments in the market after Swiber’s fall out. We assume a 0% long-term growth.
    • While Ezion’s FY16E ROE is only 4.1%, many of its assets are not contributing but depreciation, interest and some costs are being incurred. We believe that ROE should see some recovery in FY17-18 as more of these assets start to contribute.
    • Our cost of equity assumption in our GGM model was also raised after Ezion’s 2Q16 results from 15% to 18% to take into account the increase in credit risk, which saw bond yield rise about 300bps since Dec 2015.
    • Catalyst for our call would come from stronger sequential growth in profits when more assets contribute. This would most likely be from 4Q16 onwards. 
    • Downside risks would be 
      1. More bankruptcies in the sector dampening sentiments further and more tightening in the credit market, 
      2. Ezion fails to get its additional assets to work due to more significant delays or even cancellations and 
      3. Substantial defaults in charter payments to Ezion from its clients.
    • The market is pricing Ezion at 0.3x P/BV, which is the level where weaker and more distressed players such as Pacific Radiance, Nam Cheong and Ezra are trading at. However, the bond markets are pricing Ezion’s bonds at 8.4% yield vs 23-33% yields for the weaker players.

    Yeak Chee Keong CFA Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2016-08-24
    Maybank Kim Eng SGX Stock Analyst Report BUY Maintain BUY 0.450 Same 0.450