Soechi Lines is a shipping company which offer end-to-end solutions and is engaged in two core business segments: shipping and shipyard.
SOCI’s shipping business provides tanker charter services to Oil & Gas and chemical companies operating in Indonesia. It owns and operates a fleet of tankers consisting of floating storage and offloading (FSO) tankers, oil tankers, gas tankers, and chemical tankers. As of 2016, SOCI has a fleet of 37 tankers with a total capacity of 1.54million DWT. It owns 20% market share according to DWT.
SOCI’s shipping business benefits from Indonesia’s cabotage law which provides shipping companies with a final tax of 1.2%, to increase their competitiveness compared to foreign ships which are subject to a 20% withholding tax.
With 84% of shipping revenue sourced from time charters (this figure has increased to around 95% in Sep’17), SOCI enjoys stable revenue from operating its vessels. Once SOCI enters into a time charter contract, there is a very high probability for the contract to be extended, because it will be much easier for the customer to enter the contract with SOCI (rather than for a competitor to take over the contract and match the ship and contract length requirements). In addition, costs are stable because all SOCI provides to customers is a ship and a crew, with other costs such as fuel being the customer’s responsibility.
Moreover, SOCI’s revenues depend more on the volume of Oil&Gas transported in Indonesia (i.e. Indonesia’s O&G consumption), rather than the price of oil. Hence, revenues should be very stable, as evidenced from the stable revenue in an oil price downturn. From quarter to quarter, where SOCI might experience an upward/downward spike in revenue, it should mostly be caused by some ships which are in its docking cycle (docking cycle is usually every 2.5 years).
According to management, SOCI’s average vessels life is 18 years. This is partly attributable to the fact that SOCI usually buys second-hand vessels (usually aged 15 years) to use in its operations. These vessels have a useful life of 30-40 years. However, with SOCI’s strength in Repairs & Maintenance, their vessels’ useful life can reach 40 years old.
Shipping Business Maintenance Capex: $10million p.a.
Meanwhile, SOCI’s shipyard business provides shipbuilding services, dry docking and repair & maintenance services for various type of vessels.
With the shipyard business operating in Indonesia’s free-trade zone (Tanjung Balai, Karimun), SOCI enjoys exemption from VAT for its imported ship spareparts.
Unlike the shipping business, revenue in the shipyard business can be more erratic. Shipbuilding revenues will depend on the number of ships being built, as SOCI uses a percentage of completion method to recognise revenues for shipbuilding. It will also depend on the contracts SOCI is able to secure. For example, in 2017, SOCI’s 2017 shipbuilding revenues comes from the building of 7 ships, down 1 ship compared to 2016. As a result, shipbuilding revenues fall.
However, it is important to note that SOCI is not accepting shipbuilding contracts anymore, due to its difficulty (there is a need to be very precise in shipbuilding) and the strain it puts on cash flows. SOCI’s venture into shipbuilding is part of a long-term plan to build its Repairs & Maintenance business. By showing their ability in shipbuilding, they hope to convince their customers of their quality service, which will encourage them to do Repairs & Maintenance business with SOCI (instead of with foreign companies). In 9M2017, SOCI’s shipping business has a 0% EBIT margin, hence it must be a loss-making business after considering other expenses.
SOCI has spent USD200million on their shipyard which is under construction, with a 98.5% completion as of Sep’17, with expected completion in 4Q17. But profit contribution from their shipyard business has been minimal to non-existent. A future catalyst for SOCI is if they can show good performance in their Repairs & Maintenance business.
The Repairs & Maintenance business is a high-margin business with less risk, which will be a source of future recurring income. Currently, SOCI is in the process of searching new contracts for Repairs & Maintenance, whilst testing out and improving their shipping repairs capabilities by docking their own ships. Management expects the Repairs & Maintenance business to be fully operational by 2020.
Currently, Indonesia is still short of repair and maintenance areas for ships, which causes many ships to dock overseas. In addition, with the growth in number of Indonesian-flag vessels due to support from the Indonesian government, the shipyard business can be a potentially successful venture if executed well.
Pro-Forma Income Statement + Valuation + Cash Flow Statement
- Note: the above excludes forex gains/losses. SOCI had plenty of forex gains over the years due to the rise of USD. Now, SOCI has converted many of its loans to USD, which will result in lower forex gains/losses.
Future Earnings Outlook
We can expect significantly higher profits when SOCI’s Repairs & Maintenance business is fully operational, and as they complete their shipbuilding jobs (which has low/negative margins). I would expect at least an additional Rp100bn of profit from this segment.
SOCI has had very high capex in the past few years as they have been expanding their fleet, causing negative free cash flow. Although capex growth will normalise, we can still expect high capex in the near future as SOCI is looking to gain a large market share in the expanding domestic shipping business. As Indonesia looks to double its domestic oil & gas production, there will be increased demand for oil & gas carriers, and this is an opportunity for SOCI to expand. SOCI’s focus on expansion will be in larger ships, as they focus on gaining time charter contracts, which allows them more stable revenues. Note that SOCI’s portion of time charter contracts used to be 60% in 2014, but it has now increased to 95%.
With TTM earnings of Rp310Bn, at the price of Rp232/sh, SOCI is currently valued at a P/E of 5.28x and P/BV of 0.39x. In addition, it is valued at 4.85x 5-year trailing P/E.
I believe 2018 earnings can still grow materially, as SOCI increases its utilisation given its new ships bought in 2017 (9M2017 capex is at Rp417Bn), and future revenue from the high margin Repairs & Maintenance Business.
A Capital Intensive Business
SOCI’s business model is very capital intensive with revenue based on contracts. The reason SOCI’s business is very capital intensive is because:
- Over time, SOCI will need more capital to buy new ships for 2 reasons:
- Ship replacement cycle – SOCI’s vessels has a 30-40 year life
- More efficient ships with improving technology – If SOCI does not invest in these new, more efficient ships, SOCI will lose competitiveness as competitors with the new ships will face lower costs
However, I believe it is valued too cheaply at 5.3x 2017 earnings, given SOCI has a stable shipping business which has resilient earnings, and the fact that 2018 earnings is likely to grow materially (given the company’s growth initiatives and the low earnings base in 2016-17). Given 2017 earnings is closer to earnings in a bottom cycle, I believe a valuation of 10x 2017 earnings is reasonable, which will lead to a valuation of Rp440/sh.
I believe the market is currently mis-pricing the company as earnings don’t look that stable. The seemingly volatile earnings is due to SOCI venturing into new businesses, non-operational items, and the fact that it is in a high capex cycle.