DIALOG – Fundamental Analysis (21 Aug 2015)

At the time of writing, I owned shares of DIALOG.
Changes:
  1. 21 Aug 2015 – First write up of DIALOG using new style, and covers FY15 Q4 results.

Important: MYR in ‘000s except per share data

Business Profile

The Company is principally an investment holding company incorporated to manage various subsidiaries, which serve a wide spectrum of the petroleum and petrochemical industry. The Dialog Group is principally involved in providing integrated technical services to the upstream and downstream sectors in the petroleum and petrochemical industry in Malaysia. The services provided range from upstream to downstream activities encompassing:

  • Logistic services (Tank terminals and supply base) – Dialog Group has the capability to design, build, own and operate storage tank terminal and supply base. It also has the capability to design, build, own and operate centralised tankage facilities (CTF). The substances and products that can be stored at its terminals include crude oils and petroleum products, chemicals, petrochemicals and petroleum by-products. Dialog Group currently has 3 terminals namely the Kertih Terminal, Langsat Terminal and Pengerang Terminal. The Dialog Group also announced the Jubail Supply Base in Saudi Arabia. The supply base provides facilities comprising wharf for vessel berthing, bunker fuel and fresh water tank storage, workshop, warehouse and open storage yard. The primary scope of business includes provision of marine logistic services, supply of bunker fuel, fresh water, drilling fluids, materials required for offshore operations and material handling services.
  • Specialist products and services
  • Plant maintenance and catalyst handling services, such as multi-disciplined plant maintenance, shutdown, turnaround and plant upgrading services ranging from detailed planning and preparation to execution and assistance to start-up of plants
  • Engineering and construction
  • Fabrication – The Dialog Group has 5 fabrication yards set up to support its customers in respective areas. These are located at Banting, Johor Bahru, Kertih and Nilai in Peninsular Malaysia. It has also set up a yard at Jubail, Saudi Arabia.
  • Upstream services, including sub-surface, drilling, reservoir tracing, etc
  • ePayment technology and solutions

The following chart shows revenue by geographical locations in 2015.

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Ownership

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Economic Moats

Cost Advantage (Moat: None)

  • Moderate profit margin

Switching Costs (Moat: Wide)

  • Contracts in O&G sector usually are for long term. Thus, it is unlikely Government and Petronas switch contractors or suppliers
  • DIALOG is the largest player in tank terminals in Malaysia

Network Effect (Moat: Narrow)

  • High demand in oil tank due to high supply of oil

Intangible Assets (Moat: Wide)

  • DIALOG is a leading integrated technical services provider to the upstream and downstream sectors in the petroleum and petrochemical industry.
  • One of the key players under Malaysia’s ETP due to strong relationship with Government.

Efficient Scale (Moat: Wide)

  • Same with Intangible Assets

Scale

EBITDA increased in the past 5 years, but EBITDA margin decreased from FY11 to FY14 due to higher operating expenses. In FY15, DIALOG managed to improve its margin to 18.8% (FY14: 12.8%) By Moody’s standard, EBITDA margin of DIALOG can be rated as Ba. To get Aaa rating, DIALOG margin must exceed 60%.

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ROIC and CROIC declined since FY12 due to increased investments in Pengerang. You may wonder why CROIC was higher than ROIC in FY10 and FY11. The reason being is high dividends/investment Incomes and interest income. In FY15, DIALOG’s ROIC and CROIC was return 15.3% and 21.9% respectively.

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Larger scale, in terms of PP&E, is an indication of the degree of hard asset coverage of long term debt. PP&E is a better indicator of long term debt coverage than total assets, which can be inflated by significant working capital assets, such as from marketing operations, including back-to-back buy/sell arrangements, or from significant intangible assets, such as goodwill. This also helps to better absorb risks to a midstream company’s operations or financial performance. A larger scale implies a platform for sustainable earnings and cash flows and can also have a positive effect on a company’s relative market position. Economies of scale could be derived from wider spreading of resources and cheaper supply procurement.

From FY11 to FY13, capital expenditure allocated by DIALOG in Pengerang increased from 53,519 (FY11) to 313,338 (FY13). In FY14, its capex dropped to 168,998 (FY14) due to reduction in development of tank terminals. One thing makes me puzzled is “Development of tank terminals” turned to positive (FY15: 255,955; FY14: -48,408) in “Cash Flows From Investing Activities”. I think I can only get the explanation in the full annual report.

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Financial Leverage & Distribution Profile

Financial flexibility is crucial for midstream MLPs due to their heavy reliance on the capital markets. Financial leverage and distribution profile can provide an indication as to how well a company might cope through periods of industry weakness, its capacity to incur additional debt and its balance sheet flexibility. Because midstream companies’ generally exhibit high distributions that cause book equity to erode over time, coverage measures are more useful than capitalization measures in assessing their ability to service their debt obligations. We look at three ratios:

  1. Interest coverage (EBITDA / Interest)
  2. Leverage (Debt / EBITDA)
  3. Distribution coverage (FFO – Maintenance Capex / Distributions)

The amount of leverage with which management operates and its dividend payout profile are choices and a direct result of its financial strategy. Midstream issuers actively manage to these ratios. In addition, these ratios are often used by providers of capital in the form of specific covenant tests.

Leverage taken by DIALOG was 1.94x as of FY15. We can rate this as A.

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For interest coverage, it was 20.64x in FY14. We can rate this as Aaa.

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Distribution coverage is defined as Funds Flow from Operations (FFO) less maintenance capital expenditures divided by distributions. Maintenance capital expenditures are generally based on public disclosures of maintenance capital spending or, if not disclosed, 100% of a company’s annual depreciation and amortization expense, and our forward view of maintenance spending requirements. Companies with lower payouts and which apply free cash flow towards debt reduction and reinvestment map to higher ratings. High distribution coverage provides companies with cushion during periods of weaker earnings, particularly those companies with higher levels of cash flow volatility, and provides a higher level of financial flexibility.

As of FY14, distribution coverage of DIALOG was 2.03x. This is rated as A.

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In overall, DIALOG has no issue to pay their interest expense, but level of their leverage is not bad. Besides, their distribution coverage is good. Thus, I believe that DIALOG should be able to maintain good dividend payout.

FY15 Q4 Results

4QFY15 net income of 65,237 (-24% QoQ, +18% YoY) took FY15 core net profit to 285,298 (+24.7% YoY). Total revenue for the current financial year was 2,358,183, 7.6% lower against 2,551,690 recorded last year. As for the current reporting quarter, the revenue of 576,584 million was lower by 10.4% against corresponding quarter last year while net profits after tax increased by 18.2% to 65,237. Higher margin 18.8% was recorded (FY14: 12.8%). The strong performance mainly driven by:

  1. The completion of engineering and construction activities for Pengerang Terminal Phase 1
  2. Commencement of works on the Phase 2 development
  3. More fabrication activities
  4. Maiden contribution from upstream activities as a result of the operation of the D35, D21 and J4 Production Sharing Contracts

On the International front, revenue for the current reporting quarter and year to date were lower by 20% against same periods last year. This was mainly attributable to low activities in engineering, construction and plant maintenance in Singapore and fabrication in Australia and New Zealand and lower sales of specialist products and services. Despite the lower revenue, International operation recorded higher net profits after tax by 20.8% for the financial year mainly due to the gain on disposal of other investment in quarter two of the current financial year.

The Group’s share of joint ventures results for the current year was lower when compared to the last financial year. This was mainly attributable to the share of operating and finance cost in Pengerang Independent Terminals which recently commenced its full operation and the write off of non recoverable cost in a joint venture that involves in upstream activities in quarter two of the current financial year.

Growth Drivers

  • 8 Sep 2014 – DIALOG has completed the farm out of 20% participating interest in the production sharing contract (PSC) for the three fields – D35, D21 and J4 located offshore Sarawak with ROC Oil (Sarawak) Sdn Bhd.
  • 14 Nov 2014 – DIALOG will hold a 25% equity stake in the regasification terminal that will be built to serve the massive Pengerang Integrated Complex
  • 5 Feb 2015 – Dialog has leased its storage tanks to BP plc and Total SA
  • 3 Apr 2015 – Dialog’s shareholders had today approved the company’s plan to raise funds for investments in two projects with a collective value of RM9 billion in Pengerang, Johor.
  • 13 May 2015 – Pengerang Terminal Phase 1 has already commenced operations in 3Q15 post completion of construction of Phase 1C. Currently, some EPCC works are already on-going for Phase 2.

Issues/Risks/Challenges

  • 10 Apr 2014 – DIALOG received an arbitration notice from Tanjung Langsat Port Sdn Bhd (TLP).
  • Petronas Capex cut estimate of MYR40-60bn a year. Although not a new information to the market, the breakdown was not fully known. During 2009-2013 capex spending averaged MYR45bn per annum, with domestic capex average of MYR28bn (63%), and international capex average of MYR17bn (37%). 9M14 capex spending was MYR42.7bn; domestic capex: MYR24bn (56%) and international capex: MYR19bn (44%).
  • Weak international revenue
  • 25 Feb 2015 – DIALOG’s risk service contract (RSC) for the Balai Cluster marginal oilfield project could be facing a setback as Petronas will likely postpone the project’s second phase until crude oil prices go back to at least US$80 per barrel
  • 20 Mar 2015 – Financing for long term projects

Shareholder Return

The table below is a simulation of shareholder return. Assumptions:

  1. Commission paid is ignored in this simulation.
  2. The current price is as of the time of writing.
  3. Unit purchased is 1,000.
  4. Stock price as of 21 Aug 2015 was 1.52.
  5. DIALOG went through few capital changes in the past few years. You can check Bursa announcement.
Time Frame Date Bought at Original Value Dividend Received Dividend Yield % Unrealized  Gain/Loss Current Return CAGR %
3-Y 21/08/2012 2.41 2,410.00 85.17 3.5% -897.90 1,597.47 -12.8%
5-Y 20/08/2010 1.1 1,100.00 145.17 13.2% 412.10 1,657.27 8.5%
10-Y 19/08/2005 0.278 278.00 296.33 106.6% 1,264.34 1,838.67 20.8%

Valuation

EY% Valuation

  • Trailing:
  • FY15 (EPS: 0.054) – 1.78 (Uncertainty Risk: MEDIUM)
  • R4Q (EPS: 0.054) – 1.78 (Uncertainty Risk: MEDIUM)
  • Forward:
  • FY16 (EPS: 0.059 ± 5%) – From 1.85 to 2.04 (Uncertainty Risk: MEDIUM)
  • FY17 (EPS: 0.067 ± 5%) – From 2.10 to 2.32 (Uncertainty Risk: LOW to MEDIUM)
  • EPS applied to reach the current stock price (1.52): 0.046

I think fair value of DIALOG is from 1.85 to 2.04.

Going Forward

The group is on track to build on its long-term recurring income stream generating asset base with multiple tank terminals put in place to capitalize on the potential growth in Malaysia’s downstream sector in RAPID.

DIALOG valuation is not bad now. I will continue to hold and accumulate DIALOG.

Resources

Excel – http://1drv.ms/1NpFP8Y

Notes – http://tinyurl.com/nsvtjyj

4Q15 Quarterly Report – http://www.bursamalaysia.com/market/listed-companies/company-announcements/4835577

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