Singapore’s oil and gas industry has been seeing money flowing back as investors banked on a global recovery. Reflecting this phenomenon, the FTSE ST oil and gas index has posted an impressive 10.5 percent gain to 369 points. Despite the gains, the sector index is still half of what it used to be – at above 700 points during its peak.

In 2014, billions of dollars of market value were wiped out when the crude oil bubble burst and oil prices came down like a ton of bricks. At its lowest, WTI crude oil price was only US$29 per barrel in January 2016, compared to US$110 per barrel prior to the crash. Since then, WTI crude oil has been clawing back up and is currently hovering around US$50 per barrel, spurring sentiments that the industry has bottomed out.

Foreboding a recover is underway, Shares Investment was intrigued when Kim Heng Offshore & Marine Holdings’ (Kim Heng) purchased three Anchor Handling Tug Supply (AHTS) vessels. We paid a visit to the local-listed company’s shipyard in Penjuru Road and spoke to the management to learn about the current dynamics in the offshore and marine sector.

Market Is Still Tight

One of the key points Kim Heng’s management brought across is that the industry is “not all about oil prices”.

Yes, higher oil prices dictate higher level of oil activity. But to completely apply that logic in a broad way on every sub-sector would be out of context. To put things in perspective, consider the parallel scenario that the local construction sector has shrank 5.6 percent in 2Q17 despite resurging land banking activities amongst local property developers. Even recently, City Developments made headlines for its record $907 million bid for a piece of freehold land.

Whilst higher oil prices have generally given support to major oil producers and national oil companies like Royal Dutch Shell, Exxon Mobil and Saudi Aramco, the positive effects have yet to truly trickle down to rig builders and offshore service providers like Kim Heng.

Of those hit by the collapse of oil price, the offshore and marine sector was most adversely affected as production costs in offshore waters can be exponentially higher than onshore production. For instance, the marginal production costs of Saudia Arabia’s predominantly onshore oilfields could be as low as US$3 per barrel while the marginal production costs of oil in the offshore Artic region could be as high as US$120 per barrel.

Consequently, the challenges every offshore company faces are also characterised by their respective operating region. For Kim Heng who specialises in the maintenance, repair and overhaul (MRO) of offshore rigs, its bulk of income comes from rigs that pass through Singapore’s waters.

Kim Heng commands a lion share of about 65 to 85 percent of offshore MRO in Singapore. During brighter days, the company worked on as many as 67 rigs in 2014, but the eventual dry spell for contracts came and the company only took on 15 MRO jobs in the current year, the lowest since oil price tumbled.

Adding more to its woes, the four local offshore MRO players are now facing the possibility of competing against the mighty Keppel Corporation (Keppel) which the latter has always played within the newbuild space. Even disregarding Keppel’s prospective entry, new MRO contract flows may not resurface meaningfully in Singapore in the short-term horizon.

Not All About Oil Price

At the end of the day, management plays a crucial role in the longevity of a business. Amidst the severe downturn, former stock darlings like Nam Cheong Holdings, Swiber Holdings (Swiber), Marco Polo Marine and possibly Ezion Holdings, have all been snuffed out. Kim Heng is one of the few offshore service providers left on the Singapore Exchange (SGX), and is still standing strong.

In fact, the company listed on the SGX in 2014, raising $43.5 million of gross proceeds right before the fall of oil prices. Only recently did Kim Heng utilise its proceeds for business purposes, specifically for the recent acquisition of three AHTS vessels.

What is interesting though was that the three AHTS vessels were previously owned by Swiber and subsequently repossessed by a syndicate of banks when Swiber went belly-up. Kim Heng paid a total consideration of just US$9.6 million for the three vessels which were valued at US$33 million each when they were built in 2010. The company utilised $8.5 million from IPO gross proceeds and the remaining $5 million will be drawn down from an existing bank loan.

Without having to make calculations to factor in depreciation charges, it would not take much to know that Kim Heng acquired the assets at a huge bargain. Assuming each vessel has a scrap value of US$1 million, Kim Heng’s management intimated that the principal plus interest to finance the purchase of each vessel can be 40 to 50 percent below the existing market charter rates of US$8,500 to US$10,000 per day.

Acquiring these AHTS vessels at such a huge discount to value, Kim Heng could be expecting magnified returns from these vessels even if it tenders for contracts at more competitive prices than its peers. Proving yet again, as the old adage goes, that the best time to invest is when everyone is afraid.

Management Is Key

Back in the heydays when the offshore and marine sector was gearing up and taking more debt to expand, Kim Heng chose to remain prudent and it has turned out to be a blessing in disguise. In fact in FY14, Kim Heng’s total debt was only $8.1 million and total debt-to-equity was only 8.3 percent. Today, the management’s position remains unchanged and as of 1H17, the company’s total debt-to-equity was still manageable at 30.9 percent, with debt of $27.3 million.

Kim Heng’s sound balance sheet has allowed the company to withstand the protracted headwinds yet at the same time given it the financial headroom to capitalise on attractive opportunities.  Wise and prudent investment choices also alleviate the challenges of getting these assets into productive activities since they can be priced more competitively. Of the three recently acquired AHTS vessels, two have already secured charter contracts, with the third expecting to secure a contract in 4Q17.

That being said, uninformed investors might be apprehended to know that Kim Heng’s fleet utilisation rate is quite underwhelming, at only about 50 to 60 percent. Inclusive of the recent AHTS vessels, its fleet consists of seven offshore support vessels (OSVs), 10 tug vessels and 30 barges. Of those, we noticed that three OSVs, four tug vessels and one barge are at least 20 years of age.

As oil majors would not contract OSVs above the age of 15 before the end of the charter contract, such old-age assets in Kim Heng’s book should either have been partially or fully-impaired, or out-of-depreciable life. However, Kim Heng is utilising some of these assets to service other projects which do not have such requirement in the ASEAN region like emergency responses to National Environment Agency (Pulau Tekong oil spill) or Sentosa Boardwalk project.

As such, while these old-age assets may sit in the books and weigh on utilisation rate, their implied return-on-investment could actually be superior since they have negligible depreciation charges.

A Silver Lining

Still, the ongoing headwinds have taken a toll on Kim Heng’s financial performance. The company’s net loss ballooned to $17.8 million on $31.4 million in revenue in FY16, compared to a net profit of $5.6 million and revenue of $78 million in FY14.

Impairment of the carry value is understandably unavoidable during such a period and Kim Heng recorded $8.3 million of non-cash impairment loss in FY16. Excluding this, net loss would be $9.5 million in FY16 compared to $4.9 million in FY15. The trend is likely to continue in FY17 but impairment charges are expected to be of smaller magnitude.

Notwithstanding that, Kim Heng has no chartered vessels scheduled for a major inspection in the next 12 months. Barring any unforeseen circumstances, no disruption in revenue from chartered vessels is anticipated.

If we were look at the global AHTS market per se, almost 800 vessels are stacked and not utilised but not many of these vessels can react readily to contracts because a good proportion of them are not maintained. In a way, the true oversupply dynamics of global OSVs could therefore be overstated.

For Kim Heng, maintaining an operational leverage against its peers is vital to catching new contract orders. Time will tell when the industry has really bottomed out, but Kim Heng knows that it is the management’s job to position the company to capture such opportunities. With harsh-environment exploration and development activities seeing signs of picking up in the North Sea, a sustained recovery in the industry could come sooner than later.