Singapore Shipping Corp – A Mistaken Revenue Assumption!

Singapore Shipping Corp announced it’s full year result not too long ago.

• Current Share Price: SG$0.27
• Number of Outstanding Shares: 436 mil
• Current Annualized Dividend Per Share: SG$0.01 ( 3.7% Dividend Yield)

The result was largely positive on the surface.. However, when the share price open at the next trading day, prices fell 4 cents to close at $0.27.

What could have cause the fall in share price?

A Change in Ship Owning Revenue Accounting

If you look at the net profits and the free cash flow, they are better than last year.

• Q4 FY 2015 Net Profit: US$2.3 mil
• Q4 FY 2016 Net Profit: US$1.2 mil

This is strange. Last year fourth quarter, SSC’s result included only a few weeks of contribution from Taurus Leader. This year’s fourth quarter should be better. Much of the performance was eroded by higher financing cost and unfavorable exchange rate.

What was notable was revenue being the same. That shouldn’t be the case. You have an  $80 million ship contributing more revenue. Revenue should be higher.

Here is the full year net profit:

• FY 2015 Net Profit: US$8.9 mil
• FY 2016 Net Profit: US$9.6 mil (+7.8%)

 

The big issue here, perhaps according to those who unloaded was in the accounting fine print.

Here is what was describe in the annual report:

Apparently the new auditors think they are not accounting the revenue conservatively.

That to me seems strange.

Let’s take a look at the accounting before this change. Typically I would think the conservative accounting is that if you render more services, you charge the same revenue because you provided more services, and your depreciation increase due to the higher usage.

Indeed this accounting problem typically occur more on the depreciation end then the revenue. The biggest example is toll roads which can be amortize based on usage instead of straight line.

In the case of ship charters, the charter rate over the tenure are typically fixed. Time charters for most shipping companies do not change.

If you look at the charter rates for business trusts Rickmers Maritime and FSL Trust, their container ships locked in at pre-2007 rates are still in force.

So if the services rendered is uniformed then there shouldn’t be a problem.

Unless…… That assumption of fixed charter is totally wrong.

There are a few evidence of this.

In the above snippet, they have already stated “this despite declining charter hire rates in subsequent years”

Secondly, If you look at the cash flow statement, there is a new account for deferred income:

From the way we see this account, the deferred income will get accumulated over time.

Somewhere a long this charter duration the cash flow will dip, and this deferred amount will be brought out to offset the falling cash flow in the income statement.

In this way throughout the charter duration, the revenue will be a consistent straight line.

The Cash Flow, however, should look rather different, much like the figure above.

I have tabulated the quarter by quarter revenue, EBIT from ship owning below:

If we focus on the quarterly EBIT margin, which I DID NOT RESTATE, you can see that from Q2 2015, the new ships starts contributing, and the margins started going up, after being stable at 33%-38%.

In particular, when the full contribution set in from Q1 2016 to Q3 2o16, the margins look outstanding.

At the back of my mind I was surprised by the splendid deal that they have gotten.

Once this new accounting kicks in, the EBIT margin dropped back.

It looks like we were over the moon for the wrong reasons.

We need to revalue the business

The conclusion of this revelation is that we have erred in our profit and cash flow computation and this affects whether at this point or at various price, SSC is expensive, cheap or fair.

This is business prospecting.

When your thesis is wrong, you revisit and recompute. You re-evaluate.

Then you hold, sell or buy based on your conclusion.

How do we correct this?

We know that from this year onwards, SSC financial statements will reflect the new accounting where the revenue should be more consistent. That is good enough to value the remaining charter duration.

The net profit of US$9.6 mil reflects the full contribution of the 5 ships and cougar logistics in a challenging logistics year.

It is lower than my past US$14 mil estimation.

At current price in USD, market cap US$87.2 mil, enterprise value US$169.50 mil, EBITDA US$16.46, the price earnings is 9 times and the EV/EBITDA is 10.3 times.

Valuation should take into consideration the profile of what it buys you.

1. For a portfolio of ships that is touted to be chartered to blue chip charterers for a rather long duration, investing in SSC is like investing in a leveraged bond.
2. The assumption of their leveraged bond model is that they do not have an issue finding exceptional deals, and have the financing to purchase it.

 

Given this profile, 9 times PE looks rather fair considering most shipping companies, due to their cyclical nature trades at a lower PE.

SSC with its charter predictability, trades at a  higher PE.

Still, if you invert it, your earnings yield is 11% and in this low yield environment, it is rather fair.

If there isn’t any growth, which has to come via leverage acquisitions of new ships, there is not much reason it should trade higher than this. Our original earnings assumption would have yielded SG$0.43 to SG$0.45 cents on a PE of 10 times.

My gauge of EV/EBITDA is that if its 5-7 times it is cheap, 8-9 times it is fair, 10-13 times is what private equity would pay for an acquisition and work their magic to improve the margins.

Based on this, SSC isn’t very cheap either.

Value lies in SSC ability to Grow

Growth doesn’t happen over night and I got a sneaky feeling that when SSC acquires, it will be more like last time, where they purchase three ships in one year.

The balance sheet in the current year looks in a better position to start acquiring, considering they would have free up about US$ 4.8 mil a year in retained cash + US$13 mil in existing cash to act as the down payment for a second hand ship (or 2 second hand ships on higher leverage)

It is a question whether NYK will provide SSC with more of similar deals.

Judging by the need to change accounting, I would think that the change in accounting is a direct result of the charter of these three new ships, terms that SSC have to accept in order to work with the “blue chip charterer”.

In this case we have to wonder if this is what SSC have to subject to for future deals from NYK.

Nyk perhaps not just have to take care of this Singapore charterer but also their Japanese counterparts, and couldn’t possibly give all the deals to SSC.

The igniting factor for this business is really, when they make their next acquisition. The next move would clearly signal the risk management, relationship building, and execution of the young management team.

Would a 3.7% Dividend Yield be Good Enough for Shareholders?

In an era where traditional companies have to compete with dividend stocks such as REITs, business trusts, banks, telecom companies yield between 4%-10%, a 3.7% yield looks rather mediocre.

However, do note that these dividend stocks are leveraged (doesn’t mean SSC is not, their leverage is higher) and pays out majority of their earnings or cash flow as dividends (SSC earnings payout ratio is 36%)

The dividend is intact.

SSC have the following cash flow stream:

• Net cash from operating activities: +US$25 mil
• Capex (PPE and Dry Dock): -US$1.7 mil
• Principal Repayment: -US$12.1 mil
• Interest Expense: -US$2.9 mil

SSC’s free cash flow is 25-1.7-12.1-2.9 = US$8.3 mil. They can pay the US$3.5 mil for the SG$0.01 dividend and have some retain cash to build up for acquisition.

How do you see SSC at this point?

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