In previous blog posts I’ve highlighted three key issues that would give confidence to investors to continue holding this stock, namely:
- a revenue increase leading straight to the bottom line
- a reduction of net debt net by circa $50 million (to circa $250 million) as a hat tip towards greater control of indebtedness and
- an increase in EPS.
Well earnings have decreased slightly on a diluted basis from 9.93 to 9.91 and revenue increased by over 8% but the cost of sales increased by 25% by comparison:
Cost of sales increased by 25% to US$ 40.0 million (H1 2014: US$ 32.0 million) on account of increased operating expenses of US$ 4.4 million and an increase in depreciation and amortisation charges on vessels of US$3.6 million, both of which mainly arise from the addition of 2 new vessels to the fleet which increased the SESV fleet size by 20% during the period. Cost of sales as a percentage of revenue increased to 41% (H1 2014: 35%) mainly due to revenue growth being impacted by the vessels which were temporarily taken out of service to undergo upgrades and modifications as part of a number of special projects
This alone gives rise to a weaker income statement overall for example Note 6 to the accounts saw an increase in the weighted average number of shares.
Net debt increased to $374 million as a result in a reduction in cash at the bank, an increase in finance leases (both negligible) but the main culprit for net debt inflation is an increase in bank borrowings.
From note 10 to the accounts:
…a facility of US$ 85 million has been drawn down during the period to fund the purchase of a leased small class vessel and to fund the ongoing new build programme…
Fair enough but I’m still not convinced that taking on more debt is a smart thing to do given the current oil price shenanigans.
Duncan Anderson, CEO
We expect earnings to increase in the second half of 2015 now that two of our three new build vessels scheduled for this year have been delivered and because of the reduction in special projects and vessel modifications. Net income for the full year is expected to be broadly in line with expectations.
This is why I look at debt and earnings and not dividends as a way to value a stock:
Given the Group’s continued success in winning contracts for the new vessels, we expect to see growth in our revenue earning capacity feeding through to the bottom line and dividend prospects in 2016 and thereafter. As the period of capital investment associated with the current new build programme concludes in 2016 and the Group captures the earnings benefit from the enlarged fleet, the Board will consider the appropriate dividend policy that balances the opportunities to invest to continue to grow the business with the potential for increased shareholder returns
Bottom line is that only one out of three items on my bucket list was achieved (increased revenue) and the impact of cost of sales kind of took the shine off of it but here are some things to consider:
- Full year guidance is for an increase in revenue and earnings
- Less technically complicated contracts in the second half of 2015 will give rise to increased net income according to the CEO.
- Management are excellent at securing contracts for their low cost offering which is giving them the confidence to raise debt levels to invest into their fleet.
- The oil price environment is a threat to the way management like to increase debt to fund expansion and has already negatively impacted operations in Europe by their own admission
- Oil production from MENA countries will not decrease anytime soon not because they need the cash (which they do) but because a sanctionless Iran will reclaim lost market share very quickly
We are a leading player in the Middle East, where we have been supporting well service and maintenance activities for almost 40 years. The majority of the Group’s SESV fleet is located in the region, many of which are working under long-term contracts offshore off Abu Dhabi. The new build programme is progressing well with the next vessel, the Mid-Size GMS Scirocco, due for delivery as planned in Q3 2015.
The good people at GMS need to watch those debt levels as either a placing or even more debt would seriously weaken the investment case for this stock.
I’m happy to hold for now despite reduced earnings and consider GMS ‘on notice’ as a result of yesterday’s results.