FIN 7201 Corporate Finance
Individual ASSIGNMENT (A#2) (40%)
1333505778500 Capital Structure May 2018
Note: Attach this FORM as COVER SHEET (1st Visible Page)
Name of Student: SITI SAHARAH ISMAIL
Index/ID No. : I17013477
Criteria Marks Comments Marks Given
Capital Structure comparison
Assumptions 50 Poor Quality
Ok work but can improve significantly
Good piece of work / comprehensive Risk Analysis
Valuation of project
Critical Analysis 40 Poor Quality
Ok work but can improve significantly
Good piece of work / comprehensive Presentation/
Decision thought process 10 Poor Quality
Ok work but can improve significantly
Good piece of work / comprehensive Total 100 LIMITED / Poor (<60)
Overall OK/Can Improve (60-80)
Good Piece of work / Comprehensive (80-100) ______/ 40
INVESTMENT ANALYSIS ON ICON OFFSHORE BERHAD (ICON) AND ALAM MARITIM RESOURCES BERHAD (AMRB)
Table of Contents
1.0 EXECUTIVE SUMMARY 3
2.0ECONOMIC AND INDUSTRY ANALYSIS 4-5
2.1 Global Economic Conditions
2.2Overview of Maritime Industry in Malaysia
3.0 CAPITAL STRUCTURE ANALYSIS 5-8
3.1 Capital Structure Comparison
3.2 Historical Trend Analysis
3.3 Weighted Average Cost of Capital (WACC)
3.4 Summary of Findings
4.0RISK ANALYSIS 9-10
4.1Risk Analysis and Mitigation
1.0 EXECUTIVE SUMMARY
1.1 This report consist of evaluation of two (2) Offshore Support Vessels (OSV) service provider in Malaysia, which is ICON Offshore Berhad (ICON) and Alam Maritim Resources Berhad (AMRB). Both companies classified under maritime industry. ICON and AMRB are Malaysia-based OSV provider and all of the vessels are Malaysian-flagged.
1.2To date, ICON owned 35 vessels ranging from different types of OSV CITATION ICO18 l 1033 (ICON , 2018). The company was established in 1994 and being in the business for than 20 years. The company reported to be the largest IPO of the year back in 2014 with RM 945 million raised during the IPO CITATION The14 l 1033 (The Star Online, 2014).The company recorded RM 204 million revenue as at FYE 2017 with 70% of the total revenue generated from local market CITATION ICO18 l 1033 (ICON , 2018).
1.3AMRB is also among the senior OSV player in the country established 20 more than 20 years ago, AMRB currently owned and operates 42 vessels and barges CITATION AMR18 l 1033 (AMRB, 2018). The major clients are from local oil& gas operator. The company recorded RM 161 million revenue as at FYE 2017 CITATION AMR18 l 1033 (AMRB, 2018).
1.4This report provides the prospective investors and interested parties an overview covering the capital structure and risk exposure analysis between both companies and recommendation on the next step of action to be taken by both companies.
1.5This reports contains 5 main sections covering the following:
Economic & industry analysis;
Capital structure analysis;
Recommendation and conclusion
1.6Based on the findings, we continue to maintain our Neutral view with a TP of at least RM0.30 upon completion of the group debt restructuring undertaken by both companies. The conservative estimation guided by the lower global utilization rate coupled with oil price volatility that leads to the less aggressive expansion plans going forward.
HYPERLINK “https://draft.blogger.com/null” 2.0 ECONOMIC AND INDUSTRY ANALYSIS
2.1Global and Local Economic Condition
2.1.1Economic confidence rebounded strongly in the first quarter of 2018 and is now at its highest level since the series began CITATION Nar18 l 1033 (Narayanan V, 2018). A steady recovery in investment, manufacturing, and trade continues is expected to support global economic growth to edge up to 3.1 percent in 2018 after a much stronger-than-expected 2017 CITATION Wor18 l 1033 (World Bank, 2018).
2.1.2Growth in the East Asia is forecast to slip to 6.2 percent in 2018 from an estimated 6.4 percent in 2017 impacted from the moderation growth in China in 2018 CITATION Wor18 l 1033 (World Bank, 2018). As at 2017, Malaysia contributed a total of 0.4% to the global economy by GDP CITATION Mic l 1033 (Michel J.B., 2017). Malaysia is expected to achieve is economic growth of 5.3% this year as forecasted by Focus Economics, 2018 slightly slower as compared to year 2017.
2.1.3Malaysia’s inflation rate stood at 1.8% as at May 2018 CITATION Tra18 l 1033 (TradingEconomics, 2018), with GDP growth rate of 5.4% as at Q12018 CITATION BNM18 l 1033 (BNM, 2018). With the new Government’s greater transparency, governance and clarity on the direction of the economy, the Malaysian stock market is expected to bounce back as risk appetite picks up in the coming months CITATION Eco18 l 1033 (EconomyTheStar, 2018).
2.1.4As at May, 2018, the current Malaysia Public debt has reached RM 1.09 trillion equal to 80.3% of the total GDP of the country as announced by AmBank Economic Research.
2.2Overview of Maritime Industry in Malaysia 2.2.1 Malaysia has the opportunities to further develop its maritime economy, with the support of numerous shipyards, ports and terminals, in addition the expansion of the Asean Free-Trade Area (Afta) into other regions such as the Middle East will open up more opportunities for maritime players to tap a bigger market CITATION Tee18 l 1033 (Tee L.S, 2018).
2.2.2The Brent crude oil is forecasted to be in the average US$55-$60/bbl in 2018.The global offshore support vessel market is projected to grow from an estimated USD 20.06 billion in 2018 to USD 25.66 billion by 2023, at a CAGR of 5.04%, from 2018 to 2023 will indirectly affected the local market as well giving more opportunities to our local OSV players to go global.
2.2.3The government policies and incentives towards increasing the growth of oil and gas sector in Malaysia being the national key result area under the Economic Transformation Programme (“ETP”) is expected to cause a positive annual growth of at least 5% towards the year 2020 CITATION ICO18 l 1033 (ICON , 2018).
3.0 CAPITAL STRUCTURE ANALYSIS
3.1 Capital Structure Comparison
3.1.1The composition of debt and equity that a firm uses to finance its assets is called capital structure. Its represents the proportionate relationship between debt and equity. Any amount attributable to the shareholders of the firm includes paid-up share capital share premium, share deals account, reserves and surpluses fall under the ‘equity’ term. While the debt is describes as an instrument which bearing fixed interest such as loan, bond and debenture CITATION Vin14 l 1033 (Vincent K.T, 2014)3.1.2The following table shows the summarization of the capital structure comparison between ICON, AMRB and industry average based on 2017 financial statements:-
No. Particular ICON AMRB *Industry average
1. Debt to equity ratio 1.23 0.25 1.5
2. Cash to equity ratio 0.04 0.1 0.1
3. Asset to equity ratio 2.5 1.5 2.5
Source: 2017 annual report of AMRB and ICON
*Note: The industry average is based on the data collected from 11 OSV companies globally not including ICON and AMRB
3.1.1 Based on the above table, AMRB recorded the lowest DE ratio as compared to ICON and industry benchmark with 0.25, showing that the company’s debt is manageable as compared to others. In particular, AMRB has more cash than ICON and the rate is within the industry average. Despite the healthy DE ratio, AMRB is still struggling with their financial performance which impacted by the high depreciation cost of its current assets. To further strengthen the company’s financial position, AMRB has undertaken a group debt restructuring which foreseen a deferment of a total outflow amounting to RM 160 million to a later years upon completion.
3.1.2The DE ratio for ICON is considered manageable as compared to the industry average which is slightly higher. The company had successfully deferred a large portion of its capital expenditure (Capex) over the years and also undertaking a group debt restructuring to ease their cash flow.
3.1.3AMRB also recorded a lower Asset-to-Equity ratio as compared to the ICON and industry average leads to the possibility of smaller asset impairments as compared to the rest. For some other reason, the high AE ratio for some companies may be caused by the earlier impairment made by the companies.
3.2 Historical Trend Analysis
3.2.1The company’s efficiency in managing its capital structure can be reviewed via any significant changes from a historical trend analysis of its leverage ratio of the capital structure. The following chart shows 3-year historical DE Ratio and long term debt fluctuation for ICON and AMRB starting from year 2015 until 2017.
3.2.2Based on the DuPont analysis, it is indicated that ICON had re-leveraged in 2017 with the leverage ratio increased approximately 41% from the year 2015 as compared to AMRB which only recorded a very minimal movement since 2015.
3.2.3Despite the up trending pattern of the leverage ratio, both companies recorded a downtrend pattern of their long term debts which indicates that both companies had reduced their long term commitments with the financier due to the revenue fluctuation for the last 4 years affected by the plunge of global oil prices.
3.2.4However, it was noticed that the main contributor to the increments of the leverage ratio was due to the increase in the short term debts acquired within the period which mostly in terms of short term loans and also revolving credits granted by the financiers to both companies.
3.2.5Based on the data given above, ICON seems to seek more short term debt to finance its business activities and it’s further attributed by the fact that the revenue of the company has been on the downtrend pattern for the last 3 years under review.
3.2.6Should the companies do not control on the acquisition of short term financing from the financiers, the companies may be exposed to the uncertainty of repayment of the debts. Based on 2018 economic condition, the interest rates has been increased and most of it are based on the floating rate which is fluctuating over the time of tenure. Equity based financing is preferred during this vulnerable period due to the flexibility offered. The company may considered on the issuance of preference shares with the flexible terms to be agreed by both parties, investor/subscriber and issuer.
3.3 Weighted Average Cost of Capital (WACC)
3.3.1In determining project cost of capital for new business venture, Weighted Average Cost of Capital (WACC) approach is used. The WACC for both companies calculated based on the FYE 2017 and with the assumption that the cost of equity of 10%. The summary for the calculation are as follows:-
*Note: please refer to appendix for full calculation
WACC ICON = (E/V *Re) + (D/V*Rd)*(1-T) =5%
WACC AMRB = (E/V *Re) + (D/V*Rd)*(1-T) = 7%
3.3.2Based on the above WACC calculated, AMRB recorded a slightly higher average cost of capital as compared to ICON. The WACC used by the investors for investment evaluation as the WACC represents the average cost of borrowing in the company. The higher the WACC the less favorable it is to the investors due to the possibility of the company to face high exposure on the non-payment of dividend to the stakeholders/investor due to tight cash flow in the future. The company with higher WACC seems to less likely to create value to the investors. However, the perspective of the WACC is different depending on types of clients.
3.4 Summary of Findings
3.4.1Both company shows marginal decrease in their long term debt and ICON recorded a marginal increase of its DE ratio over the years. Based on the DE and AE ratios generated, it can be assumed that there are possibility that ICON has been aggressively financing its growth with debt for their business expansion or maybe acquisition of new assets with represent a total of approximately 70% over capital value of the company as at FYE 2017 as compared to its competitor, AMRB which the total debt only represent 40% over its total capital value.
4.0 RISK ANALYSIS
4.1 Risk Assessment and Mitigations
Risks and mitigation are as follows:-
No. Risks Mitigations
1. Business concentration risk
One of the key drivers of OSV market in Malaysia is PETRONAS, any change of policy or annual activities will affect the revenue for OSV owners OSV owners, AMRB and ICON should explore other source of income, such as international contract from global oil & gas players.
Fluctuation of global oil prices
The current global oil prices seems to be upside down for the last 3 years due to the strong US dollars doubled with conflict between the OPEC members. The decreased in the oil prices has caused closure of few oil platforms and subsequently affected the services provided by the OSV to their main oil & gas clients. Despite the price fluctuation, the company should put in place a strategy to leverage on opportunity to enter the Asean market with the Asean Free-Trade Area (Afta) expanding into other regions such as the Middle East.
3. Changes in regulation
Both OSV owners and crew currently do not entitle for tax exemption as enjoyed by other fellow vessels owner and crew due to the definition of OSV does not fall under Malaysian Ship under Malaysian Income Tax Act 1967 Sec. 54 A, hence it is not tax exempted. Hence the tax may affect the company’s cashflow especially during the downturn.
The cabotage policy set by the government maybe change according to the government decision solely as what had happened to Sabah where the local shipowner no longer getting the privilege under the cabotage policy. The action of uplifting the cabotage policy by the government may cause the local shipowner to close shop due to the increase of the foreign flagged vessel in our water with lower charter rate offered. The owners may consider to operate their vessels under Labuan offshore status to enjoy lower tax rate.
The OSV owners should explore global market rather than relying solely on the local market as the changes in regulation is beyond the owners control
5.1ICON’s Q-O-Q performance is slightly improving despite the revenue decreased by RM2.0 million from RM50.1 to RM 48.1 million for the quarter ended Dec 2017 and March 2018 respectively. The lower vessels utilization during the first quarter 2018 resulted to the decrement of the total revenue CITATION ICO18 l 1033 (ICON , 2018).
5.2However, the loss after tax has improved by RM40.0 million in 1Q2018 making the total losses to RM 7.6 million only as compared to RM45.9 million for the quarter ended 31 December 2017. This is due to the impairment loss on vessel of RM37.6 million in quarter ended 31 December 2017.
5.3AMRB’s performance as at 1Q2018 shows a positive sign with net income growth and revenue growth of 4.37% and 6.05 % respectively based on 5 quarter trends.the current and quick ratio stood at 1.15 and 1.14 respectively giving a stable outlook towards its current assets capability against the company’s liabilities CITATION WSJ18 l 1033 (WSJ, 2018).
5.4Both companies, AMRB and ICON are currently trading at the price of RM0.14 per share. The industry average of other local players are trading at the average of RM 0.29 per share. Looking at the current market condition, 1Q2018 performance, utilization rate and age of fleets owned by the ICON the current trading price is considered within the range. However, based on the current performance of AMRB as per 1Q2018, the book value per share stood at RM 0.63 per share giving a variance of more than 300% with current trading price given a call that the share may be a bit undervalued under current market condition.
5.5International Energy Agency via its recent report believed that the economy is still relying on the fossil fuel with oil and gas representing about 50% of the global energy mix in the long term. The consumption of oil and gas is projected to expand by 30% towards the year 2040, approximately equivalent of adding another China and India to today’s global demand. Due to this, the opportunities on OSVs deployment will continue for years subsequent to the aggressive production and exploration activities that going to take place in the near future CITATION AMR18 l 1033 (AMRB, 2018).
5.6PETRONAS being among the key drivers of OSV market in Malaysia, has announced that RM 55 billion will be spent on their CAPEX this year focusing on upstream development as reported by The Edge Markets report, 2018. Despites the cautious towards uncertainty and volatility of the recovery on the oil prices, the positive movement and back up by the key drivers certainly augurs well for the support industry and provided optimism for its future.
6.0 RECOMMENDATION AND CONCLUSION
6.1Based on the above analysis undertaken on ICON and AMRB, it is recommended that the companies to consider the following to ensure the sustainability and remain resilience in this challenging industry:-
6.1.1The companies to explore global portfolios via strategic partnership or joint venture to fully leverage on the services and global opportunities and do not rely solely on the local oil majors or clients as the local market seems to be saturated with lower production and oversupply of vessels.
6.1.2Consideration of business diversification not only focusing on the upstream business but may also consider midstream and downstream business as well in order to expand the business pipelines. The improvement on the revenue and profitability of the company will subsequently boost investors’ confidence towards the company.
6.1.3ICON to improve its debt equity ratio by considering debt restructuring or issuance new other equity instrument with competitive rate. Both companies to monitor their short term obligation to ensure the payment can be met should there will be a hiccups in collecting the current trade receivable.
6.1.4Consideration on asset revaluation to improve the balance sheet items and compensate with the depreciation cost that mounted in the income statements. The disposal of older vessels are also to be considered , being part of the cost measurement process as the ageing vessels usually tend to cause more on the dry-docking expenses and maintenance. Due to the oversupply, the clients mostly preferred young vessels more than oldies. However the disposal must be made via thorough process, taking into consideration on the outstanding loan if any and also acceptable selling price.
Based on the above findings and recommendation, it is concluded that AMRB is more favorable as compared to ICON based on the capital structure and cash-flow management. However, we continue to maintain our Neutral view with a TP of at least RM0.30 upon completion of the group debt restructuring undertaken by both companies. The conservative estimation guided by the lower global utilization rate coupled with oil price volatility that leads to the less aggressive expansion plans going forward.
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