Category Archives: YZ-Offshore & Marine

Walking away from a corporate bond deal

I came across an article on the newspaper yesterday morning that Ezion Holdings will be having a meeting with bondholders this coming Monday to present a debt restructuring plan. It reminded me that corporate and perpetual bonds were selling like hot cakes 4-5 years ago offering coupons between 5-7%. I had a chance to meet a relationship manager of a bank who was offering Swiber bonds at 7% at that time. A quick and dirty at-the-back of envelope calculation showed that the annual coupons would be a whopping amount of $17,500. Compare it with a dividend-paying stock like DBS, the capital of $250,000 to pay for a bond would have bought about 16,000 DBS shares around that time when it was trading at $16 per share. This would translate to an annual dividend of only $9,600. It’s a stark difference of $7,900 and this would recur yearly till the bond matures. This big difference in the yield could have tilted the balance to attract many investors into buying bonds than to invest in equities. Even I was salivated after making the comparison, but my sanity got better of me. There were a few things that made me feel uncomfortable about corporate bonds.

1.       Corporate bonds were extremely illiquid. Certainly, when the bond coupon is high with a relatively short maturity period, potential bond-holders would want to keep them till maturity. My guess was that most of the potential bond-holders were former property owners who had sold off their properties and had parked the money in the bank. Perhaps illiquidity was not really an issue to them. After all, properties are also illiquid, and they may take months to sell off. Perhaps, many people have overlooked the fact that a property could hold value better than many other types of assets. Even when the price is no good at that time, there would always be a next opportunity to sell some time in future. However, when a company is in distress, the bond value can fall very fast once the bad news goes public. The maturity date may be a further inhibition because potential buyers could calculate the number of expected coupons to maturity. On the buyer side, my inference was that there were not likely many too. Corporate bonds are mainly opened to the high net worth individuals (HNWI) and are not marketed to the mass market. That gave me some inkling that during the times of need, the sellers may have to depress the price significantly in order to attract a buyer. It is unlike a unit trust, whereby there is always a ready counter-party such as an asset management company or the bank, to buy over the financial product at the net asset value. 

2.       The second thought I had was – if the coupon offered was so good, then why the banks were not taking the first bite on the cherries. In all likelihood, the banks have made loans to these companies to the hilt and that all the company’s assets have already been pledged. This meant that bondholders had no recourse when things go wrong. How much could a company cough out to pay bondholders when there were no unencumbered assets to sell? Even secured lenders like the banks could be affected when the pledged assets could only fetch a fraction of their book value during fire-sales.

3.       Then there was another mind-boggling question. Why was the company prepared to pay bondholders at 7% when the banks were paying depositors less than one percent for their deposits? Bond issuers are not charity organizations to dangle a 6% difference in interest just to attract investors to buy their bonds. They probably could have made do with 3-4%.     

4.       Next is a personal finance question. Most of the target customers were probably HNWI who had sold their properties and parked their deposits in the banks awaiting the next investing opportunity. Or perhaps, they are business owners who had earned enough and parked their money in the bank. For a person, who was not born with a silver spoon or made from property sales and have to work hard to earn every single dollar, it would be difficult to part with a quarter of a million just for a single investment. Frankly, we do not have many quarters-of-a-million to spare to make sufficient diversifications for our portfolio. This would end up with a lob-sided risk concentration. It is really not a way to create a defensive portfolio.

5.       When I inquired about the effect on the company if the oil price tumbled, I did not seem to get the comfort that the RM was able to answer me adequately. Of course, at that time, I did not expect the oil price to tank so fast and so drastically from more than $100 per barrel to less than $30 in about a year. It was a naïve question as a time-filler during the conversation, but in hindsight, should have been a pertinent question to ask.

All these thoughts made me think twice about investing in bonds. Given that I still need bonds to beef up my portfolio, I decided that perpetual bond was probably the way to go. While there is no maturity date for perpetual bonds, without the $250k requirement would help me able to apportion out the amount to buy several perpetual bonds or a mixture of perpetual bonds and stocks. After all, there were several perpetual bonds on offer around that time. Genting perpetual bond was one of them. The bonds were offered in two different tranches first to institutional investors and then to retail investors one month later.  The coupon rate of 5.125% may not be as attractive, but casino operation is a cash business and it should be less risky compared to an engineering project or service company which is purely dependent on the oil price and the up-stream oil payers.

 

It has been well and good now that things have fall in place. DBS shares price have appreciated by 25% since then. Also now that Genting has decided to redeem both the institutional perpetual bonds and retail perpetual bonds by September and October 2017 respectively.

On the other hand, many issues related to corporate bonds, especially those related to the offshore and marine sectors, have still not been resolved. To date, most of the bondholders were forced to take deep haircuts. When there is no money on the table, it is likely that all the bondholders and even shareholders may be forced to swallow some bitter pills. As I know, so far two companies namely, Nam Cheong and Ausgroup have proposed to convert the bonds to equities. Perhaps, Ezion would also do likewise in the coming meeting.       

 

Brennen has been investing in the stock market for 27 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

Technology destroyed some traditional businesses (3): Keppel Corp & Sembcorp Marine

The share price of Keppel Corp ended today at $6.42. It has lost about 35%-40% its steady state value of about $10 per share 3-4 years ago.  Everyone knows that the reason for this was due to the collapse of the oil price from more than $100 at around mid-2014 to less than $30 per barrel by January 2016. In fact, traditionally, Keppel share price is closely tied to the price of crude oil. Its arch rival, Sembcorp Marine, another public-listed company on the Singapore Stock Exchange (SGX) also exhibited the same behaviour. When the oil price hit close to $150 per barrel just before the global financial crisis, Keppel share price and Sembcorp Marine went above $14 and $6 respectively. When the oil price crashed during the global financial crisis, the share price of Keppel Corp and Sembcorp Maine went south hitting below $4 and $1.50 respectively. When the oil price went up again to US$90-$100 per barrel between mid-2012 to mid-2014, their share price again swung up. This time, Keppel Corp share price held steadier at around $10, while Sembcorp Marine share price exhibited more volatility as it has other marine related segments that were also going through a very trying period. But when the oil price crashed once again from more than $100 in mid-2014 to less than $30 in January 2016, we again witnessed the crash in the share price of Keppel Corp from above $10 to less than $5 and that of Sembcorp Marine from more than $4 to less than $1.50 per share. At the moment, the oil price is about $45 per barrel and share price of Keppel Corp and Sembcorp Marine have since advanced respectively to above $6 and $1.60 per share. To sum up it up, the stock prices of these two companies bear very close co-relation with the crude oil price even to this very day.

Unfortunately, for Keppel Corp, Sembcorp Marine together with about 20 or so offshore marine related companies, they have no control over the oil price. In other words, these companies are price takers. Their businesses are tied to the price of oil, but they have no influence over it. Then, of course, this begs the next question – when can we expect the oil price to go back to its glory days of more than $100 per barrel? Frankly, I do not know as I do not have a crystal ball to tell the future. It also means that many others out there do not know the answer as well. As I had mentioned in my recent talk organized by InvestingNote recently, in order to be a big winner in stocks we need to be ahead of the others on the winning side of the curve.  This means that we have to look beyond the present situation and make a calculated guess of the future using the present data.  We may be right, we may be wrong but a calculated guess substantiated with some critical metrics and data would help us reduce the risk of being at the wrong side of the curve than not to do any homework at all.

 

As we know, oil prices, just like prices of any other commodities, depends on its demand and supply.  On the demand side, it takes a huge global demand to push up the price of oil. It can be a long-drawn war or a huge industrialization leap. All these did not take place in the last ten years. Huge oil hoarding can complicate the demand scenario as well, but ultimately there is still a need for real demand in order to push up oil prices over a longer period. Even with the Chinese economy normalizing after the global financial crisis, the oil price did not seem to show any significant change. Right now, we have gone past the industrial age in the last century and entered into the information age. So, it also means that advancement in economies is not driven so much by oil demand.  That said, it does not mean that the total global demand for oil has dropped compared to that of 20-30 years ago. On the contrary, I think global demand could have increased during all these years as more economies with huge population size opened up. What created a ceiling in the oil price lies more likely on the supply side. Over the past 30 years or so, a lot of progress has been made in harnessing alternative energies. That takes a chunk off the demand for fossil fuel.  And unlike 20-30 years ago, when crude oil is extracted either via oil wells onshore or via oil rigs offshore, a new extraction technique has begun to muscle its way into the oil extraction scene. Shale oil extraction, which we have not heard about 20 years ago, is slowly elbowing out the more expensive offshore extraction using oil rigs. In fact, the technological advancement in shale oil extraction has made it gradually cheaper. Just 10 years ago, the break even cost was between $65 and $70 per barrel, and, by now, if the oil price reaches $60 per barrel or even lower, it would have made shale oil a flourishing trade. Franking speaking, oil shale technology is not really a modern technique. The exploration was as early as in the 1980s, but the environmental issues and the low oil price during the 1990s made it temporarily shelved. It was then re-harnessed when the oil price started to climb more than 10 years ago. In fact, this oil extraction technique has made US, the world largest crude oil user, to reverse from a net oil importer to a net oil exporter. This could also be the explanation for the glut situation recently. As such, super oil tankers have to be used to store the crude oil and park offshore in hope of better oil price in the future.

 

Perhaps, the share prices of Keppel Corp and Sembcorp Marine as well as the peripheral companies may have met their lows recently, it cannot be said that their share price would drastically go up anytime soon. Unless the demand or supply situation changes so drastically beyond our imagination in the foreseeable future, it is difficult to envisage a huge demand for oil rigs. Their share prices may continue oscillate according to the oil price, but big leaps in their share price still depend on the how convincing is the demand is for oil rigs. As a matter of opinion, it may not happen in the next few months or even the next 1-2 years down the road. Hopefully, I am wrong coming from an investor’s point or view, but right from a consumer’s point of view.

 

Brennen has been investing in the stock market for 27 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

 

Capital reduction

We all know that for a company to operate, there is always a need for capital. Capital can come in the form of cash input from the owners of the company and, if the company has been profit-making, funds can also be re-channeled into the business instead of distributing to the owners. If the business is a public-listed company, then additional capital can be raised through IPOs and rights issues. All these form the equity capital for the business. There is also another type of capital known as debt capital. This involves borrowing from financial institutions such as a bank or through unsecured borrowing such as raising bonds and notes. Then, there is also preferential share, which depending on how one looks at it, can be seen as equity capital or debt capital. All these form the various avenues for the directors to tap upon to enable the company to operate as an on-going concern and, of course, to optimize shareholders’ value.

 

When a business is in need of funds, the directors would have to look into what channels can be tapped to inject funds into the business before the business run into cash-flow problems. In the past one to two years, we have seen several offshore and marine related companies and business trusts running into cash-flow problems because the business were deprived of capital injections. Swiber Holdings, Erza Holdings and Rickmers Maritime are just few eye-catching examples that cropped up recently due to difficulty in seeking additional funds for their businesses.

 

 At the other extreme, there are also companies that have ‘extra’ capital in the form of cash that it becomes necessary to carry out a capital reduction in order to optimize the capital structure of the business.  Capital reduction can come in several forms, and this usually ends positively for shareholders. It can be carried out through share-buyback program in which a company buys back its own shares and then cancels them out at the treasury. This, in the way, reduces the number of shares in the market and thus increases share price per share. OSIM as well as several American companies had previously done this after emerging from the global financial crisis in year 2009.

 

Another form of capital reduction can be in the form of returning capital back to shareholders. A good example is IPC. IPC had been a penny stock before its consolidation of 10:1 in 2015. Its share was around 3 cents in year 2004 and around 6 cents during the global financial crisis. During the normal times, the stock price had been oscillating between 9 cents and 17 cents. The business had undergone a significant transformation changing from a PC manufacturing company in the 90s to a hotel operator today. With the sale of 7 hotels in Japan followed by a share consolidation of 10 shares into 1, the company returned a total of about $136.5m to the shareholders. Hence on the balance sheet of the FY 2016 financial report, the share capital was reduced from $169,658,000 to 33,190,000. Each shareholder got cash return of $1.60 per share after consolidation even though the number of shares that one holds remains unchanged. This means that those investors who had purchased the share at an average price of 16 cents or below before the shares consolidation would have recouped and profited for investing in IPC. Of course, the share capital on the balance sheet of IPC’s financial statement is set back by $136.5m, meaning that the scale of the business has been down-sized, but who really cares if we are in a business with no money down and had enjoyed the dividends that had been distributed previously. Hopefully, going forward, the management continues to deliver and help increase shareholders value. This would help maintain the stock price and possibility of future dividends in the currently scaled-down business. Perhaps, the cash return had been partly due some pressure from the substantial shareholder, Mr Ooi Hong Leong, who owns 30% of the business. But, again as an investor, is it not what we are looking for – an investment that provides us a solid return somewhere in the future with consistent income along the way?

 

At the moment, unfortunately, the stock has been quite illiquid due to the mandatory stock consolidation. Even though there is a trading price of between 50 and 60 cents per share, it is still not worth trading the stock as it is difficult for one to buy or sell the shares optimally due to its trading liquidity, which resulted in steep share price changes.   With the only hotel business left in China, it is hoped that company delivers another magic to maintain the share price that come with future dividends. Of course, it does not preclude the fact that it may have to raise funds for expansion in the future. But at the moment, it’s a nice feeling of enjoying a significant profit and, at the same time, participating in a business with no money down due to its capital reduction exercise. 

 

 

Brennen has been investing in the stock market for 27 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy. Analyses of some individual stocks can be found in bpwlc.usefedora.com. Registration is free.

   

 

It’s time to take stock of how our stocks performed this year

At the close of calendar year 2015, the STI ended at 2882.73. And today, the last day of trading for year 2016, the STI ended at 2880.76. In effect, the STI lost less than 2 points or less than 0.07% for the year 2016.

However, if we were to slice the STI movement month-by-month within the year, it tells a different story. In the first two months, namely January and February, the STI actually fell below 2,600, down more than 10% from the beginning of the year following the uncertainties in China due to the sudden devaluation of the RMB. The free-fall that triggered the circuit breakers in the Shanghai stock exchange seemed to instil more fear than stabilising the market, causing even more selling when the market resumed. In the meantime, the oil price that reached a high of more than US$100 per barrel in 2014, had been falling throughout the year 2015 and was heading to below the $30 per barrel by January 2016. There was even a widespread fear that it could even go below $20 per barrel. Needless to say, the two simultaneous events that happened at the beginning of the year caused the Straits Times Index (STI) to dip ferociously from 2882.73 to below 2,600 losing more than 10% in less a month during January.

 

By early March, the oil price had somewhat stabilised at around $30 per barrel and made a u-turn gradually towards the $40 per barrel level. The STI that has been tracking the oil price also climbed gradually passing the 2,800 mark. However, the oil price that had been gradually falling since second half of year 2014, had already brought irreversible damage to the offshore and marine (O&M) sector. The share price of many stocks in this sector was relegated to super penny stocks when it was between 70 cents to a dollar just one to two years ago. Defaults become a commonplace for many bonds that were raised during the good times 3-4 years ago. The default of Swiber bond in the middle of 2016 triggered many O&M bond-issuers to seek bond-holders approval to re-structure the coupon payments. To date, these issues have not been fully resolved and they are likely to snowball into 2017. In the meantime, the bond defaults also spread to other sectors such as properties as well as other asset class such as perpetual bonds. Several short-term bonds and perpetual bonds that like Oxley Holdings, Aspial Corporation and Hyflux that were issued in the first half of this year had the share price fell below their respective issue price. Much to the expectations of stock investors, the surprised Britain-Exit (Brexit) in June 2016 turned out to be a non-event, at most affected a few isolated stocks on the SGX. 

 

Then, of course, the spectre of interest rate hike began to be in the forefront of investors’ mind again by the last quarter of 2016. The widely expected first interest rate hike became a reality in December after the American presidential election in early November. Shocking the political scene was the selection of Donald Trump, who was considered a rookie compared with Hillary Clinton. The interest rate hike in December as well as the expectations of more hikes into 2017 shifted the whole investing landscape. Bank shares were widely favoured while REITs and property shares lost their shine.

 

With the US presidential election behind us, it is likely that the FED has more leeway in calling the shot. Consequently, the fear of more interest rate hikes will continue to haunt investors going into the year 2017. REITs and property developer counters are likely to continue under pressure, although there could be a possibility that the government eases the property curbs especially when the economy is not functioning as expected. Although interest rate hikes are a great boost for banks’ interest margin, it is only good at the beginning of the interest rate cycle. Economic performance and non-performance loans are likely to put a lid on the banks’ profit margin going forward. In effect, the upside on the share price of banks may be limited unless the economy, on the whole, turn for the better going into 2017. Yields, be they bond yield, perpetual bond yield or REIT yield will continue to edge higher in anticipation of more interest rate hikes. This means the bond/REIT price is likely to stagnate or even experience downward bias if FED starts to be more aggressive in hiking up the interest rate. Although many REITs managed to re-finance and to resolve their loan issues for year 2017, they may start to feel pressure again into the years for 2018 and beyond.

 

Whilst the oil price has passed the $50 mark per barrel recently, it is unlikely to go very far beyond the $60 per barrel mark as shale oil is likely to supply aggressively into the oil market, thus putting a ceiling on the oil price. This means that oil rigs and peripheral industries such as OSV suppliers will still not benefit in the short term. Apart from the need for oil price to reach at least $70 per barrel level, it needs to remain sustainable at that kind of price level for at least 9 months before the oil giants can convincingly decide on investing in offshore exploration. This means that the profit visibility is still dicey for the oil and gas counters in general listed on the local stock exchange for the year 2017. For the other commodities, it appears that the worst is over after retreating in the last few years. However, it appears that the stock prices have already run up recently. Thus, I do not expect much upside unless there are some game-changing developments, which could tilt the balance in either way.

With that, let’s look forward to another interesting investing year!

 

Disclaimer – The above write-up is purely the opinion of the author, and it does not constitute an advice to buy or sell the mentioned stocks or the sector. Readers, who buy or sell stocks based on this article, are fully responsible for their own action.  

Brennen has been investing in the stock market for 26 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

There is no dearth of investors, but there is a dearth of trades

Senior Correspondent, Goh Eng Yeow, wrote an article “SGX, where have the investors gone?” He cited that economic slowdown and changing demographics are the main culprits. Perhaps these may be some contributing factors, but they have yet to fully explain why trading volume is getting much less. Personally, I think there is a confluence of factors that have been happening that lead to today’s plight.

(1) Low interest rate
First of all, we have been incubated in an extremely low interest environment for far too long. Banks are offering such a low deposit rates that it is no longer viable to keep money in the bank for a long time. These monies are starting to find its way into high yield instruments, such as bonds and notes, perpetual and REITs. Bonds & notes, unfortunately, do not involve the participation of stock remisiers as banks are the ones who brokered those deals. For perpetual and REITs, even though they appear to be trading instruments for the stocks dealers and remisiers, they are not really traded. In my opinion, many clients buy these securities to keep rather than to trade. These instruments offer a much higher yield and there is no point to trade. After all, many of these investments distribute dividends, some as frequent as every quarterly. It does not make sense to trade, especially when the most of these instruments were priced at least $0.70 and above during IPO. It is no point to trade based on a small change of 0.5 to 1.0 cents on a dollar compare to possibly 0.5 to 1.0 cents on a penny stock of say 20 cents per share. Surely, the quantum of these investments cannot be ignored in view of the amount and the number of notes and bond raised during the last few years. Even perpetual bonds were not lack of investors. As recent as just before Swiber defaulted in the bond coupon in end July this year, several perpetual bonds such as Hyflux was selling like hot cakes so much so that they upped the perpetual bond issue to $500m from the originally intended amount of $300m. The amount raised during the issue was even bigger than the company’s market capitalization of about $440m. Besides Hyflux Perennial Real Estate Holdings, Oxley Holdings, and Aspial Corp all managed to upsize their high-yield bonds due to a huge demand. Apart from these paper products, a big chunk of money could have also flowed into properties. Since the global financial crisis in 2008/2009, properties prices have been on the uptrend and the government had to introduce a series of curbs to contain the upward trend. It was only very recently that the trend seemed to have been arrested even though the transacted prices are still on the high side. So, in summary, there is actually a lot of money at the sideline waiting to pounce on opportunities that pop up from time to time. It is just that was not channelled via the stock market.

(2) Penny stock crash
Then there was the penny stock crash during October 2013, when stocks like Blumont Group, Asiasons Capital and LionGold Corp crashed, wiping out more than $5 billion in a single day on 4th October 2013. Within that week, a total of $8 billion had been wiped out. Surely, this had dented the retail investors’ confidence in trading stocks, particularly, the penny stocks. In the 12 months than followed, the trading volume and trading value shrunk by 60% and 30%. Apart from these stocks, many other unrelated penny stocks were also not spared. The crash had reduced many penny stocks to super penny stocks. So, even if the transacted did not change, the transacted amount would still be significantly lower.

(3) Minimum Trading Price (MTP) of 20 cents
The introduction of minimum trading price (MTP) of 20 cents on 1st March 2015 seemed to have taken place at wrong time and wrong place. News were then abound that the FED was considering increasing the interest rate, and this had taken a toll on the overall stock transaction volume. When the requirement was imposed, stocks have to be consolidated to meet this requirement. At that time about one-third of company stock prices on SGX were struggling below 20 cents. This requirement, forced many companies to consolidate their shares making them extremely illiquid. Even though grace periods are extended under certain circumstances, things cannot be changed overnight given that the global economy was only trudging along. Some company shares had to consolidate as much as 100 to 1 share. And after the consolidation, some share prices still fall significantly shrinking market capitalisation even further.

(4) Bond defaults
Before Swiber defaulted on its bond coupons, bond defaults were generally brushed off as isolated cases. The default by Pacific Andes Resources Development Limited (PARD) and PT Trikomsel was largely ignored. It was when Swiber defaulted that investors started to realise that the whole offshore and marine sector was at risk. Many of the related stocks started to tank and many have since become super penny stocks. Several stocks that were traded at around $1 or even more per share are now trading much lower, with some even trading below the MTP.

All in all many stocks are now at extremely low price. With a shrinking volume due to a confluence of these factors as well as extremely low price, it is no wonder than the trades via SGX keeps shrinking.

Brennen has been investing in the stock market for 26 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

Lessons learnt from the recent bond saga

Following the default of Swiber in July and a series of debt-restructuring meetings between several offshore and marine (O&M) companies and note-holders, investors are starting to come to realise that buying into notes and bonds are not the problem-free passive incomes that they had expected. Most of these meetings end up in deadlocks that drain a lot of time and energy. Interestingly, the holders of these notes are the High Net-Worth Individuals (HNWI) who purchased the notes through their respective private banking channel and are well served by relationship managers. Most of these clients are likely business-shrewd, financial savvy and have gone through many financial challenges in life to see through things before they reach this pinnacle to be a private banking client.
Are the banking clients so trusting that they simply entrust at least a quarter million dollars of their money to relationship managers without asking critical questions? Do they do the same when they buy a pair of $100 shoes or to sign up for a course for $1,000 or purchase a $200k car? Or is it that the promised rate of return is so glaring that everything else got obscured. Surely, a relationship manager (or anybody) who tries to sell us something cannot be on the same side of the negotiating table as us in a buy-sell transaction.

Ironically, most of the Investment instruments are built such as that once we get into it, there is always a price to get out, be it time, money or effort. Essentially, there are three critical factors to look into:

a. The exit plan: One key thing in investment is to know, understand and even plan the exit strategy in case the investment did not turn out as expected. If an investment does not offer as easy exit as the entry and subjecting it to a huge capital loss, then it is never a good investment no matter how good the promise can be. This does not only apply to corporate bonds, it also applies to direct selling, gold trading and land-banking investments as well. I learned this important lesson during the Asian Financial Crisis (AFC) when the Malaysian authority was about to impose currency control on the Malaysian Ringgit. During the last few days before the CLOB was closed, even good stocks were offered at steep discount. Imagine, stocks like Malayan Banking Berhad (MayBank), bought at more than S$4.00 during normal times were trading at around 70-80 cents on the very last day of the CLOB trading. This was how I learned this expensive lesson. In the case of the corporate bonds, there are basically two ways of exiting the investment, that is, either to hold the bond till maturity or to sell them off mid-way in the secondary market. Given the relatively low interest rate environment, it is very likely that most note-holders are planning to hold the bonds till maturity. In other words, there is not much liquidity in the secondary market. Furthermore, during times of crises, most of these note-holders will be at the sell side, and it is likely that existing note-holders will suffer a huge capital loss when there are no urgent buyers. So, there is almost no chance of exiting the investment midway without suffering heavy losses in the capital.

b. Rate of return:The rate of return has always been the best selling point to attract bond buyers especially with the current meagre bank interest rate. But it is also a point to ponder why companies are willing the dish out 7% (or whatever attractive percentage) when the banks are paying only 1% interest. Chances are that secured lenders like banks have decided that it is becoming too risky to continue to lend to the company, and these companies may have no choice but to turn to issuing bonds, a form of unsecured lending to get the funding that it needs. The relatively long period of low interest rate had set a stage for excessively borrowing by the companies, and all it takes is a critical factor, eg., a crash in the oil price, to knock off the company financially. It is really a high gain high risk situation that many people may not realize until it happens.

c. The liquidity factor – The primary objective of people investing in bonds lies in the hope to hold the bonds till maturity without default on the coupons and the final principal. So, in general, corporate bonds are not liquid. A good indication is the significant difference between the bid and offer spread. This means that if the bondholders sense something wrong with the issuing company, it is not easy to sell the bonds in the secondary market without a huge discount. Furthermore, note and bondholders are likely discrete individuals and it is difficult to get into a collective bargaining with the bond issuing company on equitable terms. Administratively, it is difficult to get all the bondholders together, let alone the fact that such efforts involve additional costs and time to seek legal redress.

To sum up, it is no longer a situation that one can sit back, relax and collect high passive returns just like that of one year ago.

Brennen has been investing in the stock market for 26 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

Look at each stakeholder’s perspective

Every month, when I receive my credit card bills, I would almost immediately go to the internet and post-date the payment to 1-2 days before date due, and make sure that the bill is paid in full. As far as I am concerned, I am a AAA-customer of the bank. My question is – does the bank like me? Well, not quite. Why? Simple. The bank cannot derive a profit out of me. The bank is there to make a profit, and if it cannot earn a profit out from me, I am quite sure I am not its best customer. In fact, the best customers for the bank are the ones that only pay interest without any default, and not even those that pay up part of the principal sum, let alone those that pay the full principal sum. From my perspective, the bank views me just as a credit-worthy customer and not a profitable customer. Of course, the bank will not deprive me for being a credit card customer because it still needs to maintain a healthy ratio of those who pay on time and those who only pay part of the principal sum. What is my point here? A bank’s perspective can be different from its customer’s perspective. 

 

In a similar way, a bank’s interest in lending to corporate may be different from a retail bond-holder’s interest even though both are lenders to the same company. Banks minimise their risk by securing physical assets as collaterals. That’s why they are in the business of secured lending. Given that banks have already secured the assets, their primary interest would be to achieve profitability when they lend out the funds. However, that cannot be said for an unsecured lender in retail bonds. The primary objective of an unsecured lender should, in my opinion, to focus on the risk to ensure than principal sum is protected and be returned with interest when it is lent out. However, very often, the promise of high returns tends to blind us. If we do not analyse a bit deeper, we may miss the whole picture altogether.   In fact, following the default of Swiber, several companies (need not mention them) had met with bondholders or note-holders to re-structure their debts as well as to change the payment conditions that come along with it. To get the bondholders’ support, companies very often have to make higher promises. However, higher promises do not mean safer promises in future. In fact, it could put the company’s financial future at risk due to the higher promise. One pertinent question is – how can we be so sure that the business environment in the future will be better than it is now?

Unfortunately for the bondholders or even shareholders, we do not have much say in the company executive matters except to raise some concerns. By the time, when such a meeting is called upon to discuss the re-structuring of debt payment, the damage is often already done.

For investors, whether we enter an investment as a bondholder or as a shareholder, doing it right first time is of prime importance. The effort needed to back-track is often arduous and painful.

Good luck.    

Brennen has been investing in the stock market for 26 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

Post-Swiber: Expect more difficulty for companies to raise funds

The past 12 months have been dominated by companies raising funds through bonds or perpetual issues in anticipation of interest rate hike by FED. There were no short of investors.  Many of the issues were over-subscribed, and most of these companies up-sized their bond issue way above the originally amount. Just by a stroke of their pens, they could easily raise another $50m to $100m. Aspial Corp made 2 issues within 7 months, and in the latest issue recently raised to a maximum of $200m against the original public offer of $50m for a 4-year bond at a coupon of 5.3%. Perennial Real Estate originally planned a $200m 4-year bond issue at 4.55% increased the offer size from $200m to $280m. Hyfux, whose original $300m offer of the 6% perpetual bonds also increased to $500m, even bigger than the market-cap of the company. Whether in the full-fledge corporate bond for high net worth individuals (HNWIs) or sliced tranches for retail investors, there were no short of takers. Investors see these investments as passive incomes in comparison to the bank’s paltry interest rate of less than 1%. Until late last year, defaults on bond coupon payments were almost non-existent. Even when PT Trimkosel Oke and Pacific Andes Resources defaulted more than six months ago, they seemed to be widely ignored as these companies were foreign based. Unfortunately, these bonds were sold through the private banking network, which also meant that some of the local High Net-worth Individuals (HNWIs) had also been affected.  Now with the default of Swiber, investors now suddenly realise that many high-yield bonds are prone to default and the expected return might not duly compensate for the risk. Unfortunately, the damage has already been done. Bondholders suddenly find the recently purchased notes and perpetuals now trading below par. Going forward, at least for the time being, it is unlikely that companies are able to raise funds through this avenue any more. Certainly, banks with their private banking network, are likely to scrutinize the bonds more closely before selling them to their clients.

Following the default of Swiber, banks are also likely to become more cautious with their lending programs. With the ever-increasing non-performance loans (NPLs), company financials will be scrutinized closely and asset value will be assessed with higher safety margins before banks lend out to them. It is certainly not going to be easy for companies to borrow from banks without quality collaterals on the table.

With the bank network being almost severed from them after the Swiber saga, companies may have a hard-time raising funds for their operations. They may have to resort to scaling down their operations and to sell off some of the assets, especially the inoperative ones. Unfortunately, inoperative assets are more of a liability than an asset during bad times because no company would want to stifle their own cash flow by buying assets that not revenue-generating. Even supposedly good assets that are able to preserve values over time, such as properties and land, may not fetch good prices when times are bad or when seller companies are in dire straits.

So what are other options can a company explore to raise funds? Perhaps, issue rights or raise notes or perpetual bonds from retail investors. When a company has to resort to issuing rights during such times, it is likely that company is not in a good shape. In all likelihood, the company share price is trading at their lows. Hence raising rights can be a huge challenge. Many companies, even after shares consolidation, were trading even below 20 cents, which is the Minimum Trading Price (MTP) threshold for SGX shares. Certainly, a right issue will set the trading price below the MTP putting a lot of pressure for them to make good on their share price in future.

So, in summary, even though a company may have several avenues to tap funds, the real situation may not be as rosy. We may say that some companies were lucky to be able to raise bonds before the Swiber saga. In fact, some might have felt even luckier to have raised more than their expected needs. However, we will only know if they are really that lucky somewhere in the future. Paying out coupons of 5%, 6%, 7% and even 8% is no small matter compare to paying a smaller interest to the banks. Paying a bigger quantum as coupons for an enlarged debt is even worse. They may be able to solve their operating needs now, but it is really kicking the bucket down the road because they have to pay for a higher price in future. In all likelihood, companies may have exhausted all the channels of getting cheaper funds, and they have to resort to paying a higher interest to attract investors. Investors, instead of zooming and be attracted the expected return, should now turn the table around and ask himself a critical question. Why does the company willing to pay me 6% (or 7% or 8%) per year in coupons when the bank rate is only around 1%. Only when one starts to ask himself such critical questions would he then become less bias in his thoughts.

Take Care!

Brennen has been investing in the stock market for 26 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

Swiber bonds

After paying for the maturing bonds, Swiber’s debt remains at $551m. (see table). Assuming that all the bonds were issued at $250k per unit, it would meant that each bondholder held more than one unit of bond in all the tranches that had been issued. It could even be possible that some shareholders held bonds in several tranches.

For example, if the $100m bond that was issued on 10 April 2014 were to slice in units of $250,000 each, it would mean that there were 400 units available for sale. Assuming that all units were treated equally (pari passu) and given that there were only 268 bondholders for that tranche, it means that the bond holders hold an average of 1.49 units. This means that each bondholder had bought either one or two units of bonds for that tranche on average. In other words, their exposure is $250k and $500k. It may even possible that some bondholders hold three units or more. The same goes for the bond that that was issued on 18 April 2013, which averaged about 2.36 units per bondholder, meaning that each bondholder invested $500k or $750k. For the other issues, comparatively fewer bondholders could mean that they are corporate bondholders such insurance companies, finance companies or fund managers investing on behalf of their clients.

Given the relatively short tenor, it is likely that these bonds were bought with the intent to hold them till maturity. In other words, it would mean that there is no ‘supply’ in the secondary market. Similarly, I do believe that buyers are not quick to buy these bonds because there were many in the market with somewhat high yields at that time, including REITs and perpetual bonds. Furthermore, the quantum of $250k per unit may have put many potential bondholders off from buying these corporate bonds. In other words, there was not likely to be too much liquidity. The bid and offer prices are likely to be far apart. To certain extent, each new bond issue appeared to show higher promise than the previous ones such as offering shorter tenor or higher coupon rate. This might be a tell-tale sign of initial trouble. It may mean that the banks, often come in as secured lenders, were no longer as supportable, and the company has no choice but to tap on unsecured lenders via bond issues. In order to sell well, the conditions had to be extremely favourable to the bondholders. The yield of 6% to 7% looked extremely enticing in view that the banks were paying an interest of less than 1%. The shorter and shorter tenors would mean that the maturity dates would be clustered around the financial year 2017 and this would put a lot of pressure on the company going forward.

Perhaps many people might have overlooked one critical point. For the industry to continue to flourish, the oil price must stay consistently above a certain level. My take was that it should be around $75/$80 per barrel. (Even DBS CEO mentioned in TODAY, Tuesday 9 Aug that ”even at US$40-$45, many are cancelling contracts.”) Unfortunately, oil price level is not within their control. The high yield of 6%-7% could have probably blinded all the financial risks that potential bondholders are likely to shoulder. The promise of higher return made it a very easy sell for the bank relationship managers. Unfortunately, that high yield could be an indication that the company is taking on higher risks and therefore it has to promise bondholders of a higher return to match the risk. Unfortunately for the industry, the oil price has been dropping significantly and is currently languishing around $40 per barrel causing many contracts for offshore oil exploration to be cancelled or, in the best case, delayed. The cake is no longer sufficient to feed all the peripheral businesses surrounding the offshore marine industry.  Even if the oil price were to climb back to $50/$60 level, it is expected that shale oil drillers will be very active to recover their developmental costs for the last few years. This is likely to keep a lid on the oil price making it difficult for offshore drillers industry to re-enter the market.

Brennen has been investing in the stock market for 26 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

 

Oil prices and related stocks

If you have been reading and following the oil trends back in the seventies, you would probably have come across some futuristic books such as from Alvin Toffler mentioning that fossil fuel is likely to be depleted in 50 years’ time from then. Using that as the beginning of the real time line, it means that ‘that future’ is not too far away, perhaps within a matter of 10-15 years from now. So, based on the ever-increasing demand especially with recent developments of China, a super consumer of oil, and with the depleting oil supply, we should expect oil prices to reach sky-high. Perhaps by now, it should be at least US$300 per barrel and beyond. Unfortunately, or maybe fortunately depending on each individual’s point of view,  the real situation right now is that the oil price is just barely above $40.  In fact, there were reports of global glut and it may be that the oil price could fall below $40 per barrel once again. Mapping out the change in the price of oil from the seventies till today, I doubt it is even able to catch up with the inflation rate.

What has led to this situation? First of all, there are huge advancements in harnessing alternative energies such as solar, wind, tidal, geo-thermal and even agricultural palm oil just to name a few. The developments in harnessing the respective alternative energies have made the world become less dependent on fossil fuel. Even within the segment on fossil fuel, there were also huge leaps in oil discoveries. In the nineties were significant advances in oil rig developments. This has enabled us to tap oil from the deep-sea beds. More recently, huge developments in shale oil exploration came to the forefront. Frankly speaking, shale oil exploration is not a new technology. It has been known in the 80s, but the environmental effect and cost of tapping shale oil have prohibited its developments until very recently when the oil price shot above $80 per barrel for a historically long time.

So, what is my point here? The developments in the area of oil exploration and discoveries have made oil price extremely low. In fact, even huge oil consumer such as United States, who had been a net importer in the 70s and 80s, has become a net oil exporter recently due to huge developments in shale oil. The OPEC, a powerful organisation more than thirty years ago, has become quite powerless in controlling the oil price. To cut the story short, the situation is that each time when the oil price reaches a certain level, new discoveries and extraction methods would help to bring the oil price down.

To help readers better understand the oil situation in a nutshell, I have tabled out the following information. (Also see picture in this link which summarised the oil price scenario.) That, hopefully, helps for people who are interested in this industry, in particular the oil-rigs related companies.

  1. If the oil price falls below $40, countries with land-based oil fields can still make money. It means that countries like Saudi Arabia, Kuwait, UAE, Venezuela, Iraq, Iran, and Algeria will continue to produce because their cost of production is far below $20 per barrel. However, companies (or countries) related to shale oil and offshore rigs are unable to produce oil profitably.
  2. If oil price falls in the price range of $40-$60 per barrel. Some efficient oil shale companies may be able to start production. Even though they may be marginally profitable or even operating at a loss, they are still able to cover part of the developmental costs. In this price range, oil rigs and offshore-related companies are still unable to start production as it is still not profitable for them.
  3. If oil price falls in the price range of $60-$80 per barrel. Some efficient offshore rigs may be able to start producing, perhaps in the North Sea or seas off Brazil and Mexico. This will also be the price range which shale oil industry will be able to produce comfortably with reasonably good profit. Consequently, shale oil companies may elbow out some less efficient offshore oil companies.  At this price range, not every company that are involved in offshore oil production can be profitable.
  4. If oil price holds above $80 – generally all production segments should be economically viable to start production. Oil rigs companies should generally be profitable. At this price range, there are sufficient oil rig orders to keep oil-rig companies as well as the peripheral companies that support the oil rig companies to be very busy. We should expect huge orders for oil rigs and these works order can keep these companies above water for several years down the road. Of course, under this situation, land-based oil companies will be laughing all their way to the bank as the profit is several folds above the production costs.

Notice also that many of the oil-rigs and the peripheral companies had blossomed in the past few years. It was because the oil price had been stubbornly high for a historical long stretch of time. For about 7 years between March 2007 and December 2014, it had consistently stayed above $80 per barrel except for a brief period during the global financial crisis in 2008/2009. At this juncture, it is also important to mention another critical condition that has to come to existence for oil rigs related companies to be in business. Not only must the oil price stay about $80, it must also be sustainable for a sufficiently long stretch of time. Let’s say if the oil were to increase suddenly to above $80 per barrel for 2 months and drop back to $40, it is unlikely to pent up the demand for oil rigs. Oil developments and exploration are heavy engineering projects. Each project needs at least 2 years to develop from the initiation stage to the final delivery. (In fact, I would think even 2 years is extremely optimistic. Three to four years are probably more realistic figures.)  So, it means that in order for the demand for oil rigs to be hot again, the oil price has to stay consistently above $80 per barrel for at least 2 years. It so happened that between March 2007 and December 2014 had been a perfect period for this to happen. In the historically long period of 7 years except during the brief period of several months during the global financial crisis, the oil price has been consistently above $80 per barrel resulting in huge demand for oil rigs. This, in a way, had benefited oil rig companies like Keppel Corporation and Sembcorp Marine. Orders were so huge that they have to be lined up even into 2018/2019. Of course, all the other peripheral companies supporting the oil rig industry also benefited as well. While general optimism spun across the industry at that time, many had overlooked an important point here. I believe easily 80% of these companies are in the business of oil-rigs or supporting the offshore oil industries. Their success hinged on only one condition – the oil price must consistently stay above $80 per barrel for the whole industry to flourish. If the oil price falls below $80 per barrel, many companies may not able to operate profitably. Whether these companies are cash rich or debt-laden, the top line would definitely be hit. Furthermore, the cost of each project is so high that taking on one or two of such projects would have easily soaked up the cash-flow of the company.

Worsening the situation is that the low interest environment had made borrowing extremely easy and this could have resulted in many companies borrowing heavily in hope that the global demand come banging again. Unfortunately, since December 2014, the oil price has been heading south, and problems started to surface lately. If my assessment of the situation is correct, I think even if the oil price managed to pass the $50-$60 per barrel mark, the shale oil industry will start to gear up and this will continue to block the oil-rig companies of getting back into the market. As a matter of opinion, I believe the management of Keppel Corporation understands this well enough and quickly restructure the company by acquiring Keppel Land and transform into a conglomerate rather than to depend heavily on oil-rig business. (Thanks to the Keppel Corporation CEO, Mr Loh Chin Hua, for his far-sighted vision.) Of course, this transformation came with a price, and Keppel Corporation is now more heavily geared. Sembcorp Marine, another oil rig company, has been less fortunate. As a subsidiary company, its hands were tied and it is harder to manoeuvre its way out from oil-rig and shipyard business. Needless to say, the profit margin suffered badly. Its profit shrank 90% in the second quarter compare to that in year 2015.

Going forward, my take is that it is unlikely to see extremely high oil price in the near future. By $50-$60 per barrel, shale oil will be in the market aggressively. They need to cover their developmental costs that they had made over the past few years! With most of the local companies in the offshore marine business, it is unlikely that this industry could pick up anytime soon. Companies who borrowed heavily in hope for better times ahead will be grossly disappointed. It is a situation of ‘when the tide ebbs, we know who is really swimming naked’.

The road ahead is likely to be long and winding in the days ahead for this industry. The next 18 months or so could be the real test.

Brennen has been investing in the stock market for 26 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.