This article was written when the share price is at SG$0.137. Since then the share price have climbed to SG$0.188.
Nordic Group, a company that IPO not too long ago looks like an interesting proposition. While it does not have a long listed operating history, a change might be abound that leads me to feel we may have a good investments on our hands. Nordic operates in the volatile oil and gas, and marine sector, sectors have not been doing well and thus good hunting ground for prospective businesses to invest in.
Current share price: SG$0.137
No of outstanding shares: 400 mil
Dividend per share: SG$0.0025 final, SG$0.0025 special (3.75%)
Over the past month, Nordic acquired Austin Energy, which is in the insulation business. This acquisition looks to change Nordic’s future earnings profile to make it an attractive investment proposition. The company have also declared a 40% dividend pay out policy which is positive for investors.
Plans for IPO
Nordic group was IPOed in 2010 and from the prospectus, these are their plans for the money:
- 27.3%:increase production capacity, expansion of sales network and funding
- 4.5%: expansion of MRO and trading division
- 22.7%: expansion of companies and technologies
- 9.1%: investment in product development, improvement of work infrastructure and development of staff skills
- 27.3%: general working capital purpose
The results from the past few years seems less focus on the systems integration business, which was their original key contributor and more towards expansion of companies and technology. I felt that the company profile today looks very different from the profile that was offered to the public.
In the following few sections I will go through briefly each of Nordic group’s business segments. The main segments that will drive free cash flow in the future would be the scaffolding and insulation business.
In 2011, Nordic Group acquired Multiheight Scaffolding and Multiheight Marine business for SG$47 mil. The acquisition price was based on the aggregation of 60% FY2010 profit, 20% FY2011 profit and 20% FY2012 profit at 3.8 times.
This acquisition (slides) looks valued, and bears similarity to the current insulation business acquisition, however if you review the scaffolding segmental from the acquisition onwards the EBIT is a far cry from the SG$10 mil profit announced during the acquisition. Perhaps the majority of the profits are not as recurring as we think. Due to the weaker FY2011 and FY2012 earnings, the actual purchase cost is SG$29 mil.
Multiheight, at the time of acquisition was one of the market leaders in metal scaffolding works with more than 20 years track record. Their business involves design, erection, modification and dismantling of scaffolding system. Multiheight also rents out scaffolding parts and system.
Multiheight is one of the top 3 when it comes to scaffolding works for the oil and gas industry. Their main competitor should be familiar to small cap investors, Haileck Holdings.
Scaffolding is required during various maintenance cycle for the oil and gas industry, where the plans will shut down every 2 years. Revenue is recognized when work is carried out.
There are 2 types of maintenance:
- Order book based maintenance, the kind of shut down maintenance mentioned previously. These are considered to be higher margins
- Recurring routine day to day maintenance. Multiheight are resident contractors for Chevron and Exxon Mobil plus some smaller sites. This is based on the amount of work done so they can fluctuate as well. Recurring day to day maintenance make up 60% of the scaffolding segment.
Multiheight charges based on unit of work carried out, and that they also charge rental for scaffolds erected and labour supply.
Competition is there, with a few scaffolding, insulation and corrosion companies fighting for the contracts. However there are barriers to entry due to the strict safety standards required by the oil and gas industry. Once the company is qualified for safety, the oil and gas companies do not change contractors too much unless required. To be fair, resident contractors status is not exclusive, and Haileck does have their share of resident contractors for various customers as well. The company perhaps qualify more than 1 contractors.
Multiheight are the tier 1 contractors for scaffolding, as the lower tier contracts garnered the lower the margins. From what I understand, Haileck lost their maintenance contract with Shell, as the tier 1 contract is signed in Holland, meaning that whichever contractors the tier 1 contractor chose to engage will derive lower margins most likely.
The capital expenditure runs to 2 to 3 mil a year, which provides barriers to entry for any smaller companies to come in.
Scaffolding is a labour intensive business, as they have around 600 scaffolders who are foreign workers mainly. This would mean that in the future manpower costs will be higher and difficult. Nordic have updated that they are investing in equipment and ideas that will improve productivity to restore margins to the present levels. In any case, some of the costs can be passed on to the customers.
Multiheight would tender for all projects as long as the projects meet their hurdle rates. Due to limitation of resources if the value is too low they will not take the project. For the big oil majors, Multiheight have to maintain their residency in the plants where there are large volumes of work to be done. We get a situation where the company is constrain by their direct man power, choosing the good value contracts or serving mainly the oil majors.
During the acquisition some justification was provided on why the acquisition is attractive in that much projects were carried out with leading customers:
- Thunderhawk FPU550 semi-submersibles (2007)
- CIBA AO chemical production plant in Jurong Island (2007)
- ExxonMobil’s Singapore Hydrocarbon Fluid Expansion Project (2007)
- Chevron’s Detergent Expansion Project (2008)
- Spherical tanks at Banyan Vopak Terminal (2009)
- Carigali PTTEPI Operating Company Muda’s largest production platform in south east asia (2009)
- Singapore Parallel Train Project (2009/10)
- Air Liquide’s Hermes Project (2009/10)
- Dynamac’s BP Angola Project (2010)
- SMOE’s EKOL Accommodation Platform Project
- Foster Wheeler’s Lanxess Butylene Rubber Singapore Project
- Sembcorp Utility’s Industrial Wastewater Treatment Project
Multiheight, being the resident contractor, are also provided with a share of the latest CP expansion projects from Chevron and Aurora from Exxon Mobil and some smaller sites. These projects will run from FY2014 to FY2017.
The situation is rather unique for the scaffolding business, since they are serving the oil majors doing the maintenance. The longer the projects, the better it gets for Multiheight and the higher profit for Multiheight.
The table above tabulates the revenue, profit and profit before tax. FY2011 is low because only 6 months of results was recorded under Nordic group. FY2008-2010 was from the acquisition slides.
Nordic did not split out the project based and maintenance based results. Gross margins look good between 45-58%, and fluctuating, not reflecting a trend of being squeezed to lower prices due to high competition.
Marketing costs and financing costs are small compared to administrative costs. If you work back the administrative costs are rather standard at around SG$8 to 9 mil.
The profit before tax baseline seems to be around SG$4.3 mil. 60% of FY2014 revenue is from routine recurring day to day maintenance. It is likely that Multiheight have to take on at least one major project maintenance orders to sustain this $4 mil profit. The free cash flow should be around there at 4 to 5 mil.
The risk here is that we all know that oil prices have fallen and that this may affect the oil majors. I have heard from my friend that even BP who traditionally do not lay off staff, seem to be doing the same.
Most of the projects are maintenance based, and 70% perhaps cyclical in nature. You do not stop maintenance due to the standards that you have to comply with. However, this does not mean you cannot squeeze your contractors to optimize your costs.
While Multiheight can still garner the contracts, but they might have to sacrifice their margins compare to the last few years. For this we will have to watch the gross margins to see signs of deterioration.
The good thing is that major projects for the next 2 years have been approved so there should be minimal erosion there. However, project based business needs to keep getting new projects and future contracts being chased this year will likely see the squeeze.
No matter how defensive, my experience tells me everyone down the line gets squeezed unless you are the OEM that is the sole source.
Another risk is that for the scaffolding and insulation business, there are just the few handful of oil majors that they serve. The hearsay is that one of Hai Leck’s key customer Shell, decide to signed the maintenance contract with Dutch Hertel and Hai Leck would probably need to share revenue with Hertel. They have lost a foothole in Shell to Hertel and this will probably affect their results.
The same issue can occur to Multiheight, and Austin (although Austin does have Pharmaceutical, they have almost the same petrochemical and marine customers). The guideline is a 10% or more revenue if a single customer decides to switch.
In recent announcement, Nordic announced that they will be purchasing Austin, who is dealing with mainly insulation for SG$26 mil. We understanding from management that the NTA at the time of purchase is SG$15.9 mil, and last net profit is SG$9 mil. This looks like a splendid bolt on deal, if you look at the portfolio of service that Haileck offered, they have have listed Austin as a competitor in their insulation business.
This will likely complement Multiheight in their future tenders. However, I would urge caution in using $9 mil as the baseline PBT since this industry is very project based, and last year might be at the peak of project cycle.
It is likely a sizable proportion of the business is from maintenance business, the amount we are not sure.
And its good that this business is immediately earnings accretive, which will contribute to the bottom line.
Nordic design, procure, develop and manufacture actuators, valves and other components for assembly and integration into valve remote control systems, tank gauge systems, anti-heeling systems, alarm monitoring and power management systems. Their main market is in China where they serve 29 out of the 51 shipyards on China’s white list.
Sales have fallen off in 2010 to 2011, due to the shipping downturn. Since then, profit have been less than $1 mil. The administrative, marketing and debt cost have been consistent, and have not shown dramatic inflation.
The main problem lies in that gross margins have weaken, not to mention that revenues in 2011 to 2013 have decline. It only recovered in 2014.
There looks to be a consistent $20-22 mil cost of sales despite the size of the revenue. The system integration business looks like any order book business whereby much have to depend on sales. Without adequate sales, operating leverage works against them. The deterioration in gross margins seem to signify little competitive advantage, and Nordic competing based on price.
All that seems ready to change. In 4th quarter of 2014, Nordic secured an expanded conversion job worth US $2 mil, compared to the typical SG $700k contract.
What changed was that Nordic recently entered OEM agreements with Praxis in the Netherlands, PSM in UK to expand the range of products. The potential here is that what used to be a $200k contract can be upsized to $2 mil should the customer be interested in the full range of upgrades. Margins should be able to maintained which would mean higher revenue per customer should the new range of products prove attractive.
Nordic, in this segment, design and build tooling systems for customers in marine, oil and gas, aerospace, medical and electronic manufacturing service industries.
Precision engineering have never been a good business, plague by high competition, unstable and declining margins. Perhaps only certain precision engineering firm with a few firm customers can attain consistent margins (UMS comes to mind)
Over the past 6 years revenue have grown very well. Gross margins have been a little bit erratic. The main problem that i see is the administrative cost which increase nearly 100% in FY2012.
Since then PBT have remain weak. To be honest i was impressed that they remain profitable for the past 5 years.
SG$ mil of consistent profit looks pathetic but if you compute based on earnings yield its 1.8%! Not too bad!
MRO and Trading
Nordic in this segment engages in maintenance, repair and overhaul as well as trading and providing supply of materials, spare parts and components to their customers. The value of each order depends on level of each system customisation, the vessel type, the shipyard’s and ship owners preferences and sub system required to complete the system.
There are currently over 1,000 vessels fitted with Nordic’s systems, and this number is steadily increasing with every delivery of new vessels. It provides Nordic Group with a steady stream of income as there is a constant need for vessels to be maintained, repaired and overhauled. However, with the recent slowdown in the building of new ships, they intend to tap into opportunities for conversion and retrofitting works to be done on existing vessels. Further, for their Trading Division intends to expand the distribution of Nordic’s actuators to countries where their Group does not have a presence. In order to achieve this, Nordic may appoint local distributors to distribute their actuators and appoint original equipment manufacturers to supply their Group with such actuators for distribution. Nordic are currently sourcing for suitable distributors in the United States of America and Europe and plan to establish the distribution networks within the next three years.
Revenue for the 6 years have largely decline to 2013 and only picked up in 2014. Gross margins have been very unstable and since there aren’t much administrative, marketing costs, this segment have been largely profitable.
Overall earnings and cash flow
With the acquisition of Austin, the profile of the company’s baseline earnings or free cash flow have shifted. I can see Multiheight and Austin forming the majority of the cash flow generated. With a conservative forecast earnings of Austin at SG $5 mil and a base earnings for Multiheight at SG$ 4 mil, I see a base earnings of SG $9 mil.
MRO and Trading, and Precision engineering will contribute SG $1.5 to 2 mil, which should be adequate to pay for the tax expense.
The upside potential for cash flow will be higher value, larger value projects for Multiheight and Austin, as well as the improvement in Systems Integration if what they say really pans out.
Nordic announced recently that they will adopt a policy of paying 40% of their earnings as dividends. They also announced they will start paying dividends half yearly.
Past Dividend History:
- 2011: SG$0.0053
- 2012: $0.0025
- 2013: $0.0025
- 2014: $0.0025
- 2015: $0.0050
Based on the $9 mil base earnings, the EPS will be SG$0.0225. On a 40% pay out. dividend per share will be SG$0.009, a 6.5% dividend yield (current price SG$0.137)
The dividend will depend on whether upcoming projects and improvement to their Systems Integration segment pans out well.
Currently the chairman Mr Chang Yeh Hong holds a 51% stake in Nordic, follow by Eric Lin and the CEO who holds 7.5%. Insiders hold a total of 69.7% of shares.
The CEO salary per month is $13k. I can see my banking friends seeing their salary comparable to hers. The majority of their fortunes are tied more to how well the share price of Nordic Group does than the salary, which better aligns shareholders and management interest.
The current price earnings of Nordic is around 6 times if I use the base SG$9 mil in earnings, not factoring any potentials. At this PE it looks cheap, but from my data, Hai Leck holdings, very much in a similar mode, and not so much mixed with EPC and tele contact service, IPOed at 6 times.
The lower valuation by the market perhaps is justified due to the volatile nature of the industry.
Its potential dividend yield of 6.5% at 27% net debt to asset and 40% pay out looks attractive, but you got to question whether my base earnings is conservative.
The upside due to the 2 year maintenance cycle for their oil and gas customer and improvement in Systems integration is what we hope will happen.
The margin of safety is buying it at conservative estimation, which is what they will earn in a mediocre year and that they will continue to be in business with the oil and gas clients, and observing whether the upside happens.
One omission from my analysis was the absence of overall financial statements. Nordic’s earnings profile in the future will be very different from in the past, as Austin Energy will be immediately contributing to the bottom line. As such the overall income statements and cash flow statements are not very meaningful.
I would rather focus on the sections that makes more impact than the sections where we won’t learn much.
Nordic as a summary, is risky, in the sense that, like Singapore Shipping Corp, the earnings profile of the business have changed. I would usually, give IPO companies a few years to see the cash flow trend, whether what we believe to be trending is actually other wise. We are always not the best analyst, and even the best analyst gets it wrong when we are not diligent in understanding the business.
The primary risk is that Austin Energy’s earnings profile proved to be too optimistic, and the reality is that this segment like all of Nordic is not as cash flow accretive as what we think. Remember that Multiheight, prior to purchase was having profit before tax as current and that what was suppose to be their main segment, the systems integration became worse in recent years. It is another reason to be more weary about IPO companies continuing their good records. IPOs are listed usually at the peak to make it appealing to investors.
The dividend policy and my estimation of future base earnings is what appeals to me, though at the back of my head, I am thinking that the project based scaffolding and insulation business may not be that recurring as I think it is.
Disclaimer: The above article is a persons perspective of his view of the business. It is not an inducement to trade, buy or sell. Stocks can move with or against fundamentals in the short run and long run. Business change and so does the perspective. The author does not bear any consequences to whether you lose your money. Making investment decisions based on articles read online alone is a very unsound way to invest.
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