Penguin International Ltd - CGS-CIMB Research 2019-05-24: Happy Fleet

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PENGUIN INTERNATIONAL LIMITED (SGX:BTM)

Penguin International Ltd - Happy Fleet

• We initiate on PENGUIN INTERNATIONAL LIMITED (SGX:BTM) with ADD and Target Price of S$0.72 based on 1x FY19F P/BV. We like this stock as it is cheap (4x FY19F P/E ex-cash currently) and profitable.
• Conservative management and diversification into defence vessels helped Penguin International. It suffered one year of net loss in FY16, while some peers went bust.
• Our FY19-21F EPS estimates are conservative (+3.5% CAGR), with potential upside of 15% to FY20F EPS from higher ship sales.

PENGUIN INTERNATIONAL LIMITED BACKGROUND

• PENGUIN INTERNATIONAL LIMITED (SGX:BTM), a Singapore home-grown designer-builder-owner-operator of aluminium high-speed marine craft, was first incorporated as a private limited company in 1976 and listed on the Singapore Exchange (SGX) Mainboard in 1997.
• Penguin International’s founder, Mr. Heng Kheng Seng, initially set up the company to operate ferries between Singapore and its offshore islands. It continued on primarily as a ferry operator up until FY11, when it disposed of its retail ferry ticketing business (Penguin Ferry Services Pte Ltd). Current executive chairman Mr Jeffrey Hing and managing director Mr James Tham took over the reins of Penguin International in 2009 and 2008, respectively.

Key business segments

• Penguin International currently organises its business broadly into two divisions, namely:
  1. shipbuilding, ship repairs and maintenance and
  2. chartering.

Shipbuilding, ship repairs and maintenance segment –

• Captures Penguin International’s shipbuilding business in which it builds vessels for stock (Build-For-Stock or BFS) with its internal cash reserves, and to order (Build-To-Order or BTO), supported by wholly-owned shipyards in Singapore and Batam. This segment accounted for the bulk of revenues since FY13, with the exception of FY16 when there were no BFS vessel sales.
• Penguin International started off by building small aluminium boats in 1995 for the domestic market under traditional build-to-order (BTO) contracts. But in the past decade, this segment’s growth has been increasingly fuelled by the company’s self-funded build-for-stock (BFS) programme for mid-sized offshore crewboats and armoured security boats. Penguin International builds crewboats for its own chartering fleet and for third-party owners and security boats solely for third-party sales. In FY14, Penguin International sought to diversify its portfolio from its “one-product” BFS offering, and started to seek out international BTO shipbuilding projects around the world, while continuing to build and sell stock vessels.
• Under the BFS model, Penguin International takes a position on future demand for its stock products (Flex crewboats and Flex Fighter security boats). Management highlighted that Penguin International only utilises cash when building for stock. For BFS sales, Penguin International will typically only recognise revenue upon completion of the sale and handover of the stock vessel. There is typically no progressive revenue recognition under BFS sales. Shipowners who default under a BFS sale will lose their deposits, with no further recourse to the shipyard.
• Under the BTO model, Penguin International enters into shipbuilding contracts to design and build vessels according to the shipowners’ specifications and schedules. Current examples include fire-fighting search-and-rescue vessels for the Singapore Civil Defence Force (SCDF), patrol boats for an Australian government agency, windfarm support vessels for an operator in Taiwan, and a passenger ferry for an African state. Typically, under a BTO contract, shipowners who default are liable for further claims from the shipyard.
• In its FY14 annual report, Penguin International said it had expanded its Singapore and Batam shipyards in a bid to deliver 50 vessels annually. In its FY18 annual report, Penguin International also mentioned that it is building its fifth workshop in Batam. See Penguin International's announcements.

Chartering segment –

• The chartering segment captures Penguin International’s vessel chartering activities and operates mostly offshore crewboats (through its wholly-owned Pelican group) and passenger ferries, supported by in-house ship management teams in Malaysia and Singapore. This segment accounted for 20-25% of revenue (S$24.7m in FY14 and S$25.5m in FY15) since FY13 with the exception of FY16 when there was minimal shipbuilding revenue.
• We understand that crewboat charters account for most of the segment’s recent revenue and profitability, with the majority of the crewboat fleet operating in Malaysia. Penguin International has mentioned that, in recent years, it has been continuing to add to its own crewboat chartering fleet (including its new Flex-42X Executive Fast Crew Boat).

Strategic sales –

• Occasionally, Penguin International also engages in opportunistic strategic sales of its own charter fleet. In FY18, Penguin International sold three Flex crewboats, which were converted in-house into Flex Fighter security boats. Gains from such sales are recognised as part of other income (which also includes other income like scrap sales).

Shipyard facilities

• Penguin International has two shipyards, one in Singapore (Penguin Shipyard International Pte Ltd) and another in Batam (PT Kim Seah Shipyard Indonesia).
• Back in FY15, Penguin International mentioned that its two shipyards had a combined capacity to produce up to 50 vessels a year (supported by 2 workshops in Singapore and 4 in Batam), assuming a 6-month build cycle for its flagship Flex crewboat/security boat. In FY18, Penguin International said it has embarked on the construction of its fifth workshop in Batam to cope with the higher workload.
• Assuming each workshop can host 3-4 standard Flex crewboats/security boats at any given time, and assuming no change in the build cycle, we believe this additional Batam workshop can add another 6-8 vessels of capacity p.a.
• Penguin Shipyard: a 14,000-sqm fully concreted shipyard with a 500-metric ton marine travelift, 2 purpose-built workshops and open-yard repair slots; 1 temporary workshop and an open yard area for dockings and repairs.
• PT Kim Seah Shipyard: a 50,000-sqm fully concreted shipyard in Batam with a 250-metric ton marine travelift, four (plus 1 under construction) purpose-built workshops and an open yard area for dockings and repairs.

Competitors

• According to a search on Penguin International carried out on IHS Sea-web (an independent maritime ship database run by IHS Markit), the company ranked number one among the world’s top 10 builders of aluminium crewboats (for total number of vessels built of 30m-50m in length) for the period between FY08-18. The next largest builder is Grandweld (Unlisted), followed by Strategic Marine [a subsidiary of Triyards Ltd (ETL SP) that is undergoing financial restructuring now], and Marsun (Unlisted) in Thailand.
• In recent times, we have also noticed Austal (ASB AU) also gaining traction within the aluminium shipbuilding race.

Clients

Build-For-Stock (BFS) vessel programme:

• According to Clarkson’s, the largest customers for Penguin International’s crew boats and security boats have historically been Miclyn Offshore (MIO AU) (owner of an estimated 40 Flex crewboats), and Multiplan Nigeria (Unlisted) (owner of an estimated 20 Flex Fighter security boats). However, with Miclyn Offshore facing financial difficulties since FY14, the majority of Penguin International’s recent sales have been to Nigerian clients (Tamrose Ventures (Unlisted)/Multiplan).
• According to Penguin International, it builds and sells armoured security boats under its Flex Fighter brand to Nigerian owners. The demand for security boats in Nigeria is driven largely by oil majors, led by ExxonMobil (XOM US) and Chevron (CVX US). The oil companies charter the security boats from Nigerian owners, who supply the crew and armed guards.
• Penguin International is also its own client having built, operated and opportunistically sold vessels on its own account in the past decade.

Build-to-Order (BTO) programme:

• Since FY14, Penguin International has diversified its client base from primarily Miclyn Offshore and Multiplan - who are dominant crewboat and security boat operators, respectively - to include government agencies in Singapore and Australia, as well as owners of other vessel types, such as windfarm support vessels, patrol boats, fireboats and passenger ferries.

Crewboat chartering division:

• Penguin International’s crewboats operate throughout Southeast Asia, but lately mostly in Malaysia, where Petronas (Unlisted) and ExxonMobil are the main drivers of offshore oil and gas activities.

Passenger ferry chartering division:

• Penguin International’s ferries operate in Singapore, where Shell Eastern Petroleum Ltd (a subsidiary of Royal Dutch Shell (RDSA, Not Rated) on Pulau Bukom and local government agencies are the primary clients. Penguin International no longer operates ferries to Batam.

PENGUIN INTERNATIONAL INVESTMENT HIGHLIGHTS

“Integrated” aluminium vessel player

• Penguin International is involved in the entire aluminium vessel building value chain in-house from designing, building and selling of aluminium ships, through to in-house owning, managing and chartering. In the event of a downturn in shipbuilding, Penguin International’s ship operating team will be able to absorb unsold stock vessels and put them to work in the charter market (as was done in FY16-17).
• According to Penguin International, its shipbuilding and ship chartering segments operate synergistically. Its chartering team regularly provides feedback to its design team, which in turn incorporates improvements and upgrades into subsequent newbuilds. Conversely, the chartering team, when opportunistically selling its old crewboats or ferries. often sends the vessels to the shipyard team for refurbishment or modification. Furthermore, Penguin International usually repairs and maintains its own vessels in-house.

Enhanced Build-To-Order (BTO) portfolio

• Back in FY14, Penguin International took the initiative to broaden its shipyards’ portfolio beyond oil and gas and its Flex crewboat/security boat, which it had been building continuously for stock since FY08. This led to Penguin International entering into a BTO contract with Horizon Ferry (Unlisted) in FY14 to build four new passenger ferries for the Batam-based operator.
• Post that, Penguin International actively participated in international tenders and won BTO contracts for two fireboats for Singapore in FY16 (one delivered at end-FY18, another to be delivered in 2Q19F), one crewboat for Bangladesh in FY17, as well as 7 patrol boats for Australia and two windfarm support vessels for Taiwan in FY18.

Armoured security boats could benefit from Nigeria’s unsafe waters

• West African offshore marine companies (i.e. Multiplan, Tamrose Ventures) have been a key market for Penguin International’s BFS armoured security vessels (Flex Fighters).
• According to the International Chamber of Commerce (ICC) International Maritime Bureau’s (IMB) 2018 annual report, Nigeria has consistently been on the top of the polls for attempted and actual piracy and armed robbery against ships since 2014, and these have not reduced with time. In 2018, Nigeria accounted for 23% of the attacks.
• The ICC IMB report reveals fewer incidents of piracy and armed robbery against ships in Nigeria in 1Q19 vs 1Q18, but reiterate that Nigerian waters remain risky for vessels, especially the port of Lagos where four incidents have been reported in 1Q19. We believe this continuing risk trend could benefit Penguin International given that it currently has a decent track record with offshore marine companies in that region, in our view.

Chartering segment, beneficiary of Petronas’s fast crew boats (FCB) programme

• Lately, most of Penguin International’s crewboats in its chartering division have been servicing Malaysian oil and gas companies.
• Back in FY17, Penguin International said it saw growth potential in “chopper swappers” – offshore personnel making a switch from helicopters to crew boats, likely with Petronas’s primary objective being safety and cost (as mentioned in Petronas’s 2018-20F outlook for the Fast Crew Boats (FCB) segment). Petronas’s positive outlook for FCBs spilled over to its 2019- 21F outlook where it raised the 3-year outlook for such vessels to 80-88 (vs. 59- 63 in its 2018-20F outlook).
• Penguin International mentioned in its FY18 annual report that there had been meaningful improvements in overall utilisation and charter rates, led by its new Flex-42X Executive Fast Crew Boat. This could continue into FY19-21F, in our view. See Penguin International's announcements.
• Penguin International’s average crewboat fleet age is three years and it mentioned that its latest Flex-42X Executive Fast Crew Boat can reach speeds of up to 30 knots and boasts 80 business class seats, active ride control, remote fuel monitoring and other modern amenities.

Continued earnings recovery in FY19F

• In its FY18 annual report, Penguin International mentioned it was optimistic about its shipbuilding and chartering prospects. The shipbuilding segment will benefit from the completion and delivery of at least nine BTO vessels in FY19F; whilst Penguin International’s FY18 statements that it is continuing to build stock Flex-fighters and the construction of a fifth workshop in Batam signal to us that Penguin International sees demand growing for both its BFS and BTO businesses. The heightened need for fast crewboats in Malaysia will buoy its chartering business, in our view.
• We forecast FY19F/20F/21F revenue to rise to S$135.7m/S$136.9m/S$138.6m and net profit to increase to S$14.9m/S$15.0m/S$15.1m.

Healthy balance sheet; boon in tough times

• Penguin International has been in a net cash position since FY11, and we believe this is largely due to its cash management policy where it does not borrow for its BFS programme.
• We believe investors will gravitate to stocks that have healthier balance sheets, as it is a safer haven in volatile markets. Penguin International currently stands as one of the few oil and gas small-cap stocks that is currently in a net cash position (as at 1Q19). Penguin International ended 1Q19 with a net cash position of S$43.8m (20 Scts/share; 45% of the current Penguin International's share price). We expect its net cash/share position to stabilise at 10 Scts/17 Scts/23 Scts in FY19F/20F/21F (we forecast higher capex in FY19F).

Attractively valued

• Penguin International is currently trading at 1Q19 P/BV of 0.65x, below the c.0.98x average of its small-to mid-cap offshore Singaporean peers – DYNA-MAC HOLDINGS LTD. (SGX:NO4) and PACC OFFSHORE SVCS HLDG LTD. (SGX:U6C) – despite its anticipated earnings recovery in FY19-21F, superior ROEs and larger net cash position.
• Penguin International is also trading below its historical peak P/BV of 1.2x in FY14 (when it hit net profit of S$30m, before the oil crisis) and just slightly above its FY14-18 average of 0.61x.

FINANCIALS

FY19-21F revenue CAGR of 8.9%

• Penguin International suffered net loss in FY16, largely due to the absence of any stock vessel sale. Ship sales fell to lows of S$9.8m in FY16 but revenue gradually improved in FY17-18 as Penguin International managed to sell down its inventory of stock crewboats/security boats as mentioned above. During the same period, Penguin International was awarded some BTO contracts and started recognising progressive shipbuilding revenue like other shipyards.
• We forecast FY19F revenue of c.S$135.7m on:
  1. higher estimated charter revenue as Penguin International continually modernises and expands its chartering fleet (Penguin International has said it is looking to increase its number of Flex-42X in FY19-21F);
  2. at least nine estimated BTO deliveries (according to Penguin International’s FY18 annual report, see Penguin International's announcements); and
  3. higher estimated vessel sales from its BFS programme (11/13/13 in FY19F/20F/21F vs. 7 in FY18).
• We believe most of the BFS and BFS deliveries (and in turn revenue recognition) will be skewed to the latter part of FY19F. Hence, revenue should be volatile and lumpy within the quarters. In 1Q19, revenue and net profit fell to S$15.8m/S$0.9m due to lack of shipbuilding sales (-39.0%/-56.6% y-o-y, respectively).
• We expect revenue growth to moderate and forecast FY20F/21F revenue of S$136.9m/S$138.6m, driven by higher BFS revenue, but partly offset by lower BTO revenue.

Other income to increase with opportunistic sales

• Occasionally, Penguin International also sells its fleet vessels to third-party clients when the opportunity arises. This has resulted in other income of S$3.1m/5.6m in FY17/18.
• Penguin International is still looking to divest older ferries and crewboats (including those slated for conversion into security boats). Hence, we forecast other income of S$6.0m p.a. in FY19-21F. Again, we believe such revenue recognition could be volatile and lumpy within the quarters.

FY19F net profit to rise 9.6% y-o-y

• The BFS model typically reaps higher gross margins and we believe this may kick into effect in FY20-21F, when BTO orders fall; but we opt to be conservative for now and have applied a GP margin of 31.5% in FY19-21F, as we believe Penguin International will continue to balance its BFS and BTO shipbuilding sales, as well as its chartering sales.
• Overall, we forecast FY19F/20F/21F net profit of S$14.9m/S$15.0m/S$15.1m.

Capex up in FY19F

• Penguin International mainly incurs capital expenditure (capex) for its own fleet programme and workshop development. Penguin International ramped up capex in FY14-15 as it was building its crewboat fleet capacity and also expanding its Singapore and Batam shipyard capacity. However, this dipped in FY16-17 as the market was in a downturn. In FY18, capex started to pick up again to S$19m, likely as Penguin International saw the market improving, in our view.
• Penguin International said FY19F capex may be more extensive given it is looking to expand its chartering fleet and due to the 5th workshop expansion. We forecast FY19F capex to grow to S$30m, and FY20-21F capex to narrow slightly to S$25m p.a. without workshop expansions.

Net cash position to be sustained

• Following the sale of its regional ferry ticketing business for S$13.5m in FY11, Penguin International has remained in a net cash position, largely due to its cash management policies and ongoing opportunistic fleet vessels sales. The lowest cash balance over this period was in FY16 (S$18m) when shipbuilding sales fell.
• Given the continued earnings recovery in FY19F, and assuming conservative cash management policies, we expect the company to remain in a net cash position in FY19-21F.

VALUATION AND RECOMMENDATION

• We believe Penguin International is entering a cycle of heightened ROEs in FY19-20F. We believe its shipyards are full, with both BFS and BTO shipbuilding projects; the need for FCBs in Malaysian waters will boost its chartering business and the ongoing security risks in Nigerian waters will drive demand for its security (Flex fighter) boats, in our view.
• We initiate coverage on Penguin International with an ADD rating and Target Price of S$0.72, based on 1x FY19F P/BV (excluding its c.S$5m investment in MARCO POLO MARINE LTD. (SGX:5LY), or 2 Scts of book value in FY18) at a 20% discount to its small-to mid-cap peers 1.2x aggregate P/BV pre-oil crisis. Note that in FY17, Penguin International took an opportunistic stake of 8.12% in Marco Polo and this was impaired slightly in FY18. Our target FY19F P/BV of 1x is below Penguin International’s historical peak P/BV of 1.2x in FY14 when its net profit was S$30m.
• We opt to use P/BV as our valuation metric for Penguin International as its historical earnings were cyclical. We believe our “valuation multiple is fair, as we forecast Penguin International’s average ROE to improve to 8.8% in FY19-21F.
• From a P/E perspective, Penguin International is currently trading at an ex-cash FY20F P/E of c.4.0x.

KEY RISKS

Build-for-stock model (BFS) risky in a downcycle

• A BFS model typically earns superior margins to the BTO model as it offers flexibility and reduced lead time to vessel owners as it is in effect providing “pre-delivery financing” to its buyers, which comes at a cost. However, given that it involves some speculative building element, there is the risk that BFS builders (including Penguin International) could be caught out and be unable to sell their vessels in a swift market downcycle.
• Case in point was Penguin International’s FY16 shipbuilding revenue which dived when there were no sales. However, should BFS sales improve, so will GP margins and in turn, net profit margins. Given the risks, since FY14, management has sought out BTO projects and grown its chartering business to create a more balanced business model that does not rely too heavily on building and selling stock vessels.

“Lumpy” earnings recognition

• The majority of Penguin International’s revenue is generated by its shipbuilding business which is “lumpy” in nature. For BFS sales, revenue is recognised upon the delivery and sale of vessels. For the BTO model, revenue is recognised progressively based on milestones. The ad-hoc nature of BFS sales and varying stages-of-completion for BTO vessels mean that Penguin International usually experiences quarterly revenue and earnings swings within a financial year. The “lumpiness” is compounded by one-off opportunistic fleet vessel sales.
• We understand that for FY19F, most deliveries will be in 2H19F; hence, revenue and net profit recognition could be skewed towards the latter part of the year. In 1Q19, revenue and net profit fell to S$15.8m/S$0.9m (vs. 1Q18:S$26m/S$2.1m and 4Q19:S$41.9m/S$7.3m) mainly due to lack of shipbuilding sales.

Volatile crude oil prices

• We believe Penguin International’s shipbuilding and ship chartering prospects are still largely contingent on the outlook for the entire offshore sector, which is still influenced by crude oil price movements and sentiment. If crude oil prices fall or become more volatile, offshore E&P activity would be impacted and shipowners may become less motivated to purchase, and oil companies may become less willing to charter, crewboats or security boats.

Key clientele risk

• Although Penguin International has found new markets and clients post-Miclyn Express Offshore (still the world’s largest owner of Penguin’s Flex crewboats YTD), it is still highly exposed to Malaysia for its crewboat charters and Nigeria for its stock security boat sales, which we estimate jointly account for more than half of the group’s revenue (as at FY88).

Cezzane SEE CGS-CIMB Research | https://research.itradecimb.com/ 2019-05-24

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