Is Sapura Energy a value trap?
Value Investing Case Study 53-1: A fundamental analysis of Sapura Energy to see whether it is a value trap or an investment opportunity. I also used the analysis to determine what to do with my investment in the company.
In 2013, Sapura Energy Berhad (Sapura or the Group) described itself as “…one of the world’s largest integrated oil and gas service and solution providers…”.
It had RM 6.9 billion in revenue with RM 664 million PAT. However, by the financial year 2024, revenue had declined to RM 4.3 billion with losses of RM 519 million.
In this article, I will look at what went wrong and consider its turnaround prospects. To be transparent I bought Sapura in 2018/19 when its prices declined in tandem with the declining crude oil prices.
I thought it was a cyclical stock with the financial resources to withstand a prolonged downtrend in crude oil prices. Unfortunately, I was wrong and the turnaround took longer than expected. Its financial position was worse than what I anticipated.
Join me as I look at the prospects of Sapura and see whether I should cut loss and exit. Sad to say, my analysis shows that Sapura is a value trap.
Should you go and short it? Well, read my Disclaimer.
Contents
- Company background
- Operating performance
- Financial position
- My investment in Sapura
- Valuation
- Is Sapura a value trap?
- Conclusion
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Company background
The present form of Sapura came from several major corporate exercises:
- 2012 merger of Sapura Crest Petroleum with Kencana Petroleum for RM 6.3 billion.
- 2013 acquisition of Seadrill Tender Rig Ltd for RM 7.7 billion.
- 2014 acquisition of Newfield Malaysia Holding Inc for RM 3.0 billion.
Following these corporate exercises, the Group had total assets of RM 34.6 billion in 2015. Of these RM 7.7 billion or 22% was for intangibles and/or goodwill. Almost all the intangibles resulted from the corporate exercises carried out from 2012 to 2015.
Sapura today described itself as a global integrated energy services and solutions provider. It operates across the entire upstream value chain, including renewables.
The Group today has 4 business segments:
- Engineering and Construction. This segment provides end-to-end turnkey Engineering, Procurement, Construction, Installation, and Commissioning (“EPCIC”) solutions for the energy industry, including renewables.
- Drilling. With five decades of experience in tender-assist drilling operations, the segment is the owner and operator of the world’s largest fleet of tender-assist drilling rigs.
- Operations and Maintenance. This segment combines cross-product lines from Hook-Up & Commissioning services, Topside Maintenance and Brownfield modification capability, Offshore Support Vessel services, and Geoscience & Geotechnical services.
- Exploration and Production. The segment currently has 5 production sharing contracts and 8 exploration permits.
Historically the Engineering and Construction segment was the biggest revenue contributor followed by the Drilling segment. Refer to Chart 1. Before 2018, these 2 segments were also the larger EBIT contributors.
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| Chart 1: Segment Performance Notes O&M = Operations and Maintenance. Energy = Exploration and Production. |
Operating performance
I looked at 2 groups of metrics to get a sense of where the business is heading. Refer to Chart 2.
- The left part of Chart 1 tracks the trends of 3 metrics – revenue, PAT, and gross profitability (gross profits/total capital employed).
- The right part of Chart 1 tracks the trends of 3 return metrics – operating return (NOPAT/total capital employed), ROE, and ROA.
You can see that the performance was not good. Revenue declined over the past 12 years. There were 7 years of losses over the past 12 years. And gross profitability has been on a downtrend since 2012.
From 2012 to 2024, the Group incurred a cumulative loss of RM 17.1 billion. Included in the loss were asset write-downs and impairments totalling RM 10.3 billion. I had earlier mentioned about the sizeable intangibles. By 2024, this had been written down to zero.
Even if you ignore the asset write-downs and impairments, the Group still incurred a cumulative loss over the past 12 years. Given the PAT trend, you should not be surprised to see declining trends for all the 3 returns.
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| Chart 2: Performance Index and Returns |
Link to crude oil prices
As a Group serving the oil & gas sector, you should not be surprised to find a strong correlation between Sapura’s revenue and crude oil prices.
From 2010 to 2024, there was an 87 % correlation between the Brent crude oil prices and Sapura revenue 3 years later. For example, a correlation analysis was carried out between oil prices in 2010 with revenue in 2013 and so on. This meant that crude oil prices explained about ¾ of the variation in Sapura’s revenue.
Crude oil prices are cyclical as shown in the left part of Chart 3 making Sapura a cyclical company. The declining oil prices since peaking in 2012 explain the declining performance of Sapura from 2016 onwards.
As oil prices declined, the order books and gross profit margins declined. This is illustrated in the right part of Chart 3. From 2013 to 2024,
- The order book declined from RM 14.7 billion to RM 5 billion.
- The gross profit margin declined from 22.2 % to negative 1.5 %.
Using the same 3 years gross profit margin lag vs Brent crude oil prices, I found the following correlations:
- 58% between order book and Brent crude oil prices.
- 43 % between gross profit margins and Brent crude oil prices.
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| Chart 3: Brent crude oil prices and Sapura Operating parameters Notes to the Brent Index vs 3 Years Lag Op Indices chart: a) The Brent index for 2013 is based on the relative crude oil prices of 2010. The 2014 index is based on the 2011 price relative to 2010 and so on. b) The indices for the operating metrics for 2013 are based on the respective values as of 2013. The values for the other years are based on the values relative to the respective 2013 values. |
To turn around the performance, the Group has to re-build its order book as well as bid at higher margins. In this context, the Group today has adopted the following mantra
“Bid Right, Execute with Discipline.”
Prospects
Sapura today is a global company in the sense that in 2023 about 56 % of its revenue came from its international operations. This was 19% in 2013. While the revenue in 2023 was only 2/3 of that in 2013, the trend of having more revenue from the international operations is a growing one.
Looking at Chart 1, you can see that the performance of Sapura would hinge on the performance of the Engineering and Construction segment as well as the Drilling segment.
These are not sunset sectors.
“Oil & Gas Engineering Services market is projected to grow from USD 50.91 Billion in 2023… exhibiting a compound annual growth rate (CAGR) of 4.50% during the forecast period (2024 - 2032).” Market Research Future
“The Oil & Gas Engineering Services Market size is estimated at USD 54.70 billion in 2024…growing at a CAGR of 7.49% during the forecast period (2024-2029” Mordor Intelligence
“The global offshore drilling market size was valued at USD 36.52 billion in 2023. The market is projected to be…by 2023…exhibiting a CAGR of 8.2 % during the forecast period” Fortune Business Insights
“The Offshore Drilling Market size is expected to grow from USD 28.12 billion in 2023…registering a CAGR of 5.02% during the forecast period (2023-2028).” Mordor Intelligence
Looking at the market projections, you can see that Sapura segment revenue in 2023 was not more than 1 % of the respective markets. The issue is not the global demand but whether Sapura has the track record to win the tenders at profitable margins.
“The operating conditions for the E&C and O&M segment have continued to be challenging. The lack of access to working capital and bank guarantee facilities remains operationally strenuous as the Group works towards its regularisation plan.” Sapura Q4 2024 announcement.
Peer comparison
I compared Sapura's performance with those of its global peers.
- TechnipFMC. The company engages in oil and gas projects, technologies, and systems and services businesses in Europe, Central Asia, the Americas, the Asia Pacific, Africa, and the Middle East.
- Fluor Corporation operates through four segments: Energy Solutions, Urban Solutions, Mission Solutions, and Others.
- John Wood Group. Headquartered in the UK, the company provides consulting, project management, and engineering solutions to energy and built environments worldwide.
- Petrofac designs, builds, manages, and maintains infrastructure for the energy industries in the United Kingdom, the Middle East, Thailand, and the Netherlands.
In terms of total assets, Sapura is small and is about the same size as Petrofac. In terms of operating performance, Sapura did the worst with about the same level of leverage.
- Sapura's average ROA over the past 12 years at 0.4 % was significantly lower than the peer average of 2.5 %.
- In terms of leverage as measured by Total Asset/Total Capital, the Sapura ratio was comparable to the peer average.
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| Table 1: Peer performance Notes: a) Based on 2023. b) 2013 to 2024 average. c) Total Asset / Total Capital. |
Financial position
Sapura relied on debt to grew its asset size.
- From 2012 to 2015, total assets increased from RM 4.2 billion to RM 34.6 billion.
- Over the same period, total debt went from RM 1.4 billion to RM 17.0 billion.
You can imagine the impact on the interest charges. In 2015, it was RM 47 million. It grew to RM 638 million by 2015.
All was fine when the earnings and cash flow was such that it could support the interest payment. But when the orders began to decline, the interest payment became a burden.
Debt restructuring
In 2016, the Group reported its first loss since 2012. Despite the improved revenue compared to 2015, the low oil and gas prices meant that the Group had to impair some of its oil and gas assets. This RM 2 billion impairment resulted in a loss after tax of RM 792 million.
While the Group turned around in 2017, the Group started to incur losses before tax from its continuing operations from 2018 onwards. As mentioned earlier, these losses were due to declining revenue, gross profit margins, and asset impairments. The relatively high interest charges aggravated the situation.
These cumulative losses reached such a stage that in 2022, it was classified as PN17 by Bursa Malaysia. To address the Group’s PN17 status, Sapura Energy appointed MIDF Amanah Investment Bank as its principal adviser to help formulate a regularisation plan.
Before the PN17 classification, the Group had recognized its poor financial position. In its 2023 Annual Report, the Group stated:
“The Group took a major step towards restructuring its debts in a fair and orderly manner through negotiations with our creditors when we obtained a Restraining Order that enabled us to initiate the Scheme of Arrangement (“SOA”) process.”
The Group also sought the assistance of the Corporate Debt Restructuring Committee to mediate debt restructuring negotiations with financiers of its Multi-Currency Financing Facilities.
To make a long story short, the process is still ongoing. In its Q4 2024 announcement, the auditors had the following to say:
“…the financial statements of the Group…have been prepared on a going concern basis, the validity of which is highly dependent on obtaining extensions of the Restraining Order and Standstill Arrangements; and the successful and timely implementation of the proposed SOA….”
The key problem for Sapura was that it grew its assets from 2012 to 2015 via debt. When it incurred operating losses and began to impair its assets, there was not enough shareholder's equity to support the losses and impairments. As such it has negative equity today.
I would expect the following once the whole scheme is worked out:
- The existing shareholders would have to take a substantial haircut. I would expect the shares to be reduced by at least 90%. In other words, if you own 100 shares you would end up with 10 shares or less.
- The creditors would probably have to take some haircuts as well and some of the amount due could be converted to shares.
- There would be new issuance of shares to raise fresh capital to replenish the negative equity.
- There would probably be a white knight who would end up as the major shareholder.
I am confident that there will be a scheme eventually as in its 2020 Annual Report, Sapura stated that its major shareholder, Permodalan Nasional Berhad, had re-designated Sapura Energy as a strategic investment company.
My investment in Sapura
I first invested in Sapura in 2018 at around RM 0.66 per share. I saw Sapura as a turnaround case.
- The fall in the oil price has affected its profits. I bought on the basis that the Group has the capability and resources to benefit from an upturn in oil prices.
- The challenge was to be solvent and be able to pay its debt or refinance it while still facing oil price uncertainty. I believe that Sapura could handle this financing issue as only about RM 4 billion of the loan is payable within 1 year.
- At that juncture, it has a negative cash conversion cycle indicating that the annual revenue of RM 8 billion could cover the loan repayment. Also favorable was the RM 2 billion cash from operations. Historically Sapura Energy had been able to refinance its loans, even in 2017 with the oil price at its bottom.
- I targeted an exit price of RM 0.85. The margin of safety will come from the 10 years it will take the NTA to reach this level based on the losses at the 2016. Also, the amended valuation by CIMB of RM 1.05 per share gave me some peace of mind.
In 2019, Sapura undertook a rights issue to which I subscribed. My rationale then was that based on FYE 2019 post-restructuring results, its NTA could cover 6 years of 2019 losses.
The final situation is that I now have substantial shares of Sapura in my 30-stock portfolio. In terms of ranking, it is just outside my top 10 stocks by purchased cost.
Overall, my average purchase cost was RM 0.39 per share. This included the conversion of the Islamic redeemable convertible preference shares that were issued under the 2019 Rights issue.
Because of the poor performance, the total dividends that I have received only amounted to 1.1 % of my total purchased cost. This meant that to break even, the market price had to increase to RM 0.39 per share. The market price as of 16 April 2024 was RM 0.05 per share.
The oil and gas sector was new to me when I first bought Sapura. I thought then that with my experience with cyclical stocks, I would be able to value Sapura correctly.
With hindsight, it did not cross my mind that Sapura was effectively a construction company. Historically I had challenges valuing construction companies due to the difficulty in projecting the cash flow for project-based operations.
Furthermore, I underestimated the time required to turn around the company. Worst still, I did not fully appreciate the negative impact of debt when things go wrong.
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Valuation
My usual approach is to triangulate the intrinsic value of a company by looking at its Asset Value and Earnings Value.
I would not attempt to determine Sapura’s Asset Value. This is not just because of its negative equity. It is also because of its debt-restricting exercise and the PN 17 regulation plans.
Any Earnings-based valuation would start with projecting its Free Cash Flow. I would say that this is very challenging given that it is undergoing a business turnaround. To give you an example.
In its Q4 2024 announcement, the Group stated that it generated RM 614 million Free Cash Flow in 2024. The Group did not state how it derived this. I worry that it is different from my definition. For example, the cash flow for FYE 2024 was:
- Cash flow from operations = RM 311 million.
- Cash flow from investments = RM 302 million.
Normally the cash flow from investments would be negative. It was positive for Sapura as there were sales of securities.
My estimates of the Free Cash to the Firm = NOPAT – Reinvestments
Reinvestment = CAPEX – Depreciation & Amortization + Net Working Capital
Based on the above formula, the Free Cash Flow to the Firm was negative RM 70 million. This is very different from what Sapura stated. I hope you see the challenges in projecting the cash flows.
Valuation model
To project Sapura's cash flow, I used a comparative method based on its peer performance as follows:
Revenue = Total Assets X Peer Asset turnover
EBIT = Revenue X Peer EBIT margin
Table 2 shows the peer margins and Asset turnover
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| Table 2: Peer EBIT margin and Asset turnover |
I then developed an Earnings Power Value model based on the Free Cash Flow to the Firm approach as shown in Table 3. Under the Earnings Power Value model, the Reinvestment is zero.
The Free Cash Flow to the Firm = EBIT X (1 – tax rate).
You can see from Table 3 that given the current debt level and number of shares we will result in a negative value of equity. This is because the value of the firm is much smaller than the debt.
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| Table 3: Valuation model |
The only way to get a positive equity value is if there are some debt write-offs. At the same time, to recapitalize Sapura, the existing shareholders would have to take a haircut.
In Table 4, I illustrate one possible scenario where the white knight is contributing RM 10 billion in new equity. For the white knight to end up without any loss,
- There needs to be a 45% reduction or hair-cut from debt.
- The existing shareholders would need a 98 % haircut.
This is just illustrative as the actual haircut from the creditors would have to be worked out with them. However, it does illustrate that the existing shareholders and creditors would have to bear some losses.
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| Table 4: Valuation with hair-cuts |
Risks and limitations
There are 2 key assumptions in my valuation:
- Peer performance.
- 10% WACC.
As a company bidding in the global market, I assumed that Sapura would achieve the same performance as its global peers. I think this is an optimistic assumption. Firstly, this assumes that its operations would proceed as “normal” despite its debt restricting and PN 17 regularization plans.
Next, Sapura performances were not as good as those of its peers. For example, it achieved 27 % asset turnover and negative 1.1 % EBIT margin from 2013 to 2024. As can be seen from Table 2, these were much lower than the peers.
I assumed that the WACC used in my valuation model is 10%. Given its financial position and the debt-restricting exercise, the current WACC would far exceed this. This 10% is on the basis the company has been restructured.
Is Sapura a value trap?
My purchased cost for Sapura is RM 0.39 per share. I expect to be the victim of a haircut and end up with only 2 % of my original shares. Effectively my cost per restructured share would be = 0.39 / 0.02 = RM 19.50 per share.
I think it is almost impossible for Sapura’s price to be equal to RM 19.50 per share. I am facing a loss.
The only reason I am not selling yet is because if I sell now, for every 100,000 shares, I would get only RM 5,000. But if I hold and even if there is a % haircut in the number of shares, I hope to get more than RM 5,000 per share.
I am hoping that PNB would aim for a smaller hair-cut for the shareholders. At the same time, I am hoping that when the regularization plan is announced, speculators would push the prices higher. Am I realistic?
Along the same lines, if you are a fresh investor buying Sapura now, your cost is RM 0.05 per share. Assuming that there is a 98% haircut, your effective cost is RM 2.50 per share.
The challenge then is determining whether the price of Sapura after the restructuring would go up to RM 2.50 per share. This is about 2.5 times the restructured Book Value. Is this realistic?
Of course, the final price would depend on the restructuring scheme. But given the many unknowns, I would think that Sapura is a value trap.
Conclusion
Sapura's current financial problem is due to not just using debt to fund its acquisitions. With hindsight, its timing was bad in carrying out the acquisitions.
The oil and gas sector experienced declining crude oil prices soon after Sapura completed it major acquisitions. The oil and gas companies began to cut investments and this reduced the number of tenders available.
When orders began to dry up, the Group suffered. There was not only a decline in the order book, but it looked as if the Group was bidding at non-viable prices.
The result is operating losses. This was made worse by the impairments. The performance deteriorated to such a stage that it had to seek creditors' protection. At the same time, it became a PN 17 counter requiring it to come up with a regularization plan.
The Group is undergoing a turnaround. And unless you are a turnaround expert and understand the debt and corporate restructuring process, this is a stock to avoid.
As for me, I will have to write off my investments in Sapura and hope to recover the losses from the better performance of other stocks in my portfolio. I am just holding onto the stocks as a speculative play.
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