Is Bumi Armada an investment opportunity?
Value Investing Case Study 63-1. A fundamental analysis of Bumi Armada to assess whether it is a value trap or an investment opportunity.
Crude oil prices have been relatively high over the past few years compared to 2014 to 2016. Because of this, the oil and gas services companies' performance has improved compared to a decade ago.
Bumi Armada Berhad (Bumi Armada or the Group) is one such group. In 2012, it was a global leader in Floating Production Storage and Offloading (“FPSO”) and one of the largest OSV (offshore supply vessel) owners in Southeast Asia.
The drop in crude oil prices from 2014 to 2016 changed its fortune. There were several rounds of asset impairments and the Group restructured its business. For example, it is today no longer in the OSV business. And profits are improving.
This article delves into the performance of Bumi Armada. Following my fundamental analysis and valuation, I do not consider Bumi Armada an investment opportunity from a long-term perspective. But all is not lost. If you are a betting person, there is a good betting opportunity.
Should you go and bet on it? Well, read my Disclaimer.
Contents
- Investment thesis
- Business background
- Operating trend
- Financial position
- Risks
- Valuation
- Conclusion
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Investment Thesis
Bumi Armada is a Malaysia-based international offshore energy facilities and services provider. Its performance in the mid-2010s suffered due to declining crude oil prices. Several rounds of asset impairments led to losses.
The Group has restructured itself and its performance over the past 3 years has improved with an average ROE of 11%. But the oil & gas sector is a cyclical one. The current market price of Bumi Armada does not reflect this cyclical picture. As such I do not see this as an investment opportunity.
Business background
Bumi Armada is a Malaysia-based international offshore energy facilities and services provider. The Group’s capabilities today include field development support, production facilities, installation & operations, pipe-laying, and hook-up & commissioning.
Its assets included FPSO, Liquefied Natural Gas (“LNG”) facilities and derrick lay-barges. Its website stated the following as its current (Jul 2024) operated assets:
- 3 wholly-owned FPSO.
- 4 jointly owned FPSO.
- 1 wholly-owned LNG floating storage unit (FSU).
- 2 construction vessels.
The current business focus of the Group is very different from that of 12 years ago. In its 2012 Annual Report, the Group described itself as:
“…a leader in FPSOs globally and one of the largest OSV (offshore supply vessel) owners and operators in South East Asia, we take pride in our assets of five FPSOs, over 40 OSVs, and three T&I vessels.”
As discussed in my articles “Are there opportunities in the Bursa Energy Services sector?”, and “Is Dayang one of the better Bursa stocks?” the Malaysian OSV sector suffered from excess capacity in the mid-2010s.
Many OSV companies had to be restructured. Bumi Armada was not spared this pain and it exited the OSV sector. Chart 1 provides an overview of its journey.
- In 2022, the Group integrated its operational FPSOs, LNG FSU, and OSV vessels into the operations business unit. The provision of engineering consultancy and project support services has been segregated as a separate business unit.
- Since 2023, Bumi Armada adopted a transition strategy to accelerate its journey towards achieving net zero carbon emissions by 2050 or earlier.
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| Chart 1: Bumi Armada journey |
Although a Malaysian-based Group, Malaysia accounted for only about 1 % of its 2023 revenue. The bulk came from overseas operations such as from Asia (excluding Malaysia), Africa, and Europe. Refer to Chart 2.
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| Chart 2: 2023 Revenue by Geographies |
Operating trends
I looked at 3 metrics to get an overview of the overall performance – revenue, PAT, and gross profitability (gross profits / total assets). Refer to the left part of Chart 3.
Revenue over the past 12 years showed a cyclical pattern growing at 2.3 % CAGR. There were 3 years of losses:
- The Group attributed the loss in 2015 to weakening oil prices that resulted in the producers delaying projects and reducing their investments.
- In 2016 the Group incurred an operating loss due to lower revenue and gross profit margins. It also wrote down about RM 1.7 billion of assets.
- There was another major asset write-down of RM 2.2 billion in 2018. These were due primarily to the OSV segment and Armada Kraken FPSO.
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| Chart 3: Performance Index and Operating Profit Note to Op Profit Profile. I broke down the operating profits into fixed costs and variable costs.
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You can see the profit performance improving post-2020. I suspect that the asset write-downs had improved the gross profits.
As such there were improvements in gross profitability and contribution margin post 2020 even though there was no significant revenue growth. The most striking thing is the reduction in the variable cost. Refer to the right part of Chart 3.
Bumi Armada operates in a cyclical sector. The challenge is figuring out whether the past 3 years performance represents the long-term cyclical picture.
Over the past 12 years, there was 57% correlation between its EBIT and Brent crude oil prices. Would this represent the future performance?
The Group did not provide much information on what influence the charter rates for their facilities.
According to Chat GPT, while FPSO charter rates are not directly pegged to crude oil prices, they are influenced by them as part of the broader economic conditions and project-specific factors in the oil and gas industry.
So, if oil prices decline and stay low for several years, I would expect Bumi Armada profits to be affected.
Returns
Given the PAT recovery post-2020, you should not be surprised to see similar patterns for the returns as illustrated in the left part of Chart 4. Over the past 12 years,
- ROE ranged from negative 69 % to positive 14 % with an average of negative 3 %.
- ROIC ranged from negative 1 % to positive 9 % with an average of positive 5 %.
These average values were lower than the current 16 % cost of equity and 12% WACC implying the Group did not create any shareholders’ value over the past 12 years.
The only positive point is ROE and ROIC have improved over the past few years. Over the past 3 years, ROE averaged 11% while ROIC averaged 9%.
A DuPont analysis showed that the uptrend in the ROIC post-2020 was due to better operating margin and asset turnover but offset by lower leverage. Refer to the right part of Chart 4.
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| Chart 4: Returns and DuPont Analysis |
Competitive profile
There are about 2 dozen Bursa listed companies under the Energy Infrastructure, Equipment & Services sector.
In my Nov 2022 article, I provided a summary of the sector's performance from 2013 to 2022. Refer to “Are there opportunities in the Bursa Energy Services sector?”
I compared Bumi Armada's revenue and return with the sector median. Post 2020, Bumi Armada delivered better performance than the sector. Refer to Chart 5.
- While the sector median revenue declined, Bumi Armada’s revenue did not follow suit.
- Bumi Armada had improving ROE.
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| Chart 5: Sector comparison |
FPSO
“Starting modestly with just two vessels in 2004, Malaysia is now home to three of the world's top 10 leased FPSO operators with a combined fleet of 20 FPSO vessels…Bumi Armada (fifth largest FPSO player in the world) leads the ranks with 9 vessels, followed by MISC (sixth largest) with 6 vessels, and Yinson (seventh largest) with 5 vessels.” Malaysia Petroleum Resources Corporation (MPRC) 2018
When I compared the performance of Bumi Armada with the FPSO peers, I found that Bumi Armada had the best EBIT margin. Its return on capital was also good.
The Bumi Armada EBIT margin was because it had better gross profit margins. However, it still had asset write-downs in 2020 and 2023 which led to lower ROE compared to Yinson for these years.
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| Chart 6: Bursa FPSO peers |
The challenge for Bumi Armada is whether it can continue to improve its performance since it is among the better performers. As I will show later, this impacts its valuation.
Financial position
I would rate Bumi Armada as financially sound based on the following:
- As of the end of Mar 2024, it had RM 944 million cash. This was equivalent to 8 % of its total assets.
- It had a debt-equity ratio of 83 % as of Mar 2024. This has come down from its 2018 high of 321 %.
- Over the past 12 years, it generated positive cash flow from operations every year.
- Over the past 12 years, it generated RM 9.7 billion in cash from the cash flow from operations compared to its cumulative net loss. This is a very good cash conversion ratio.
But I have 2 concerns:
- The Group had a poor capital allocation track record as shown in Table 1. You can see that its cash flow from operations was not sufficient for its CAPEX.
- It had a very high Reinvestment rate.
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| Table 1: 2012 to 2023 Sources and Uses of Funds |
Reinvestment
Growth needs to be funded and one metric for this is the Reinvestment rate. This is defined as:
Reinvestment with acquisitions = CAPEX & Acquisitions – Depreciation & Amortization + Net Changes in Working Capital.
I then determined the Reinvestment rate = Reinvestment / NOPAT.
Acquisitions are an integral growth driver for the company. As such I have included the annual acquisition expenditure as part of the CAPEX.
Over the past 12 years, Bumi Armada had an average Reinvestment rate of 130 %. This is not a sustainable rate.
To be fair, the bulk of the high Reinvestment was incurred in the early part of the 2010s. This was when there were high crude oil prices. Over the past few years, the Reinvestments have become negative.
Bumi Armada had RM 3.7m shareholder funds in 2012. The company had supportive shareholders who subscribed to its Bonus Issue and Rights Issue which were both completed in October 2014. This brought in RM 2 billion of funds and doubled the shares.
From 2012 to 2023, the Group incurred a cumulative loss of RM 1.4 billion. Without the rights issue, the shareholders’ funds would be reduced. Instead, it stood at RM 5.7 billion as of the end of 2023.
Valuation
As of March 2024, the NTA of Bumi Armada was RM 1.03 per share compared to its market price of RM 0.57 per share (9 Jul 2024).
Bumi Armada is undergoing a turnaround. Rather than try to project the long-term turnaround performance, I reverse-engineered the market price based on its Earnings Power Value.
Given that there was hardly any revenue growth, I used the 2023 revenue as the base. There were 2 key parameters that I varied to determine the market price.
- Contribution margin.
- Capital turnover (Revenue / total capital employed).
I found that the RM 0.57 market price represented the following performance.
- 2023 revenue.
- 7% higher than the average 2021 to 2023 contribution margin ie at 67 %.
- 7% higher than the average 2021 to 2023 capital turnover ie at 23%.
Reverse-engineering model
My Earnings Power Value of the company was derived based on the operating model as shown in the right part of Chart 2.
It was based on the Free Cash Flow to the Firm (FCFF) model where:
Value of the firm = FCFF / WACC.
FCFF = EBIT (1-t).
EBIT = Revenue X Contribution margin – Fixed cost.
Value of equity = Value of the firm + Cash – Minority Interests – Debt + excess TCE. Refer to Table 2.
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| Table 2: Reverse engineering mode |
Valuation risks and limitations
There are 4 critical issues in my valuation.
- Same revenue.
- AV > EPV.
- Non-cyclical.
- No more impairments.
I have assumed that the 2023 revenue represents the long-term revenue. This was partly because the Group facilities were operating at almost peak utilization in 2023.
“Whilst overall FPSO uptime across the fleet was almost 98% for the year, in June 2023 we experienced an unplanned shut-in of the Armada Kraken FPSO…the issue was resolved in August 2023” 2023 Annual Report.
But as I will show below, there are 2 vessels that are not operating in 2023.
According to Professor Bruce Green, when we have an EPV lower than the Asset Value, it suggests under-utilization of the assets. Bumi Armada wrote off about RM 514 million of assets in 2023.
“On the negative side, the Armada Kraken FPSO suffered a major shutdown; we had two non-cash impairments, the Armada Sterling V FPSO waited 11 months on location for the oil and gas field to start, and we did not reach agreement on a new FPSO contract nor source a new contract in the Caspian Sea.” 2023 Annual Report
I am not sure the gap between the NTA and market value signifies some potential asset write-downs. But from another perspective, you could see potential revenue growth when these 2 vessels are fully operational.
Using the reverse-engineering model with greater revenue, the value of Bumi Armada becomes RM 0.97 per share. This close to the NTA. My key assumptions for this were:
- Given that it had 8 vessels in operations in 2023, I guesstimate the other 2 vessels would increase its revenue by 25%.
- I assumed that the contribution margin would be 7% higher than the past 3 years average value.
- However, since there is no change in the total capital employed. I assumed that it would remain at RM 9.1 billion.
In my Deleum article, I mentioned the link between crude oil prices and the performance of the oil and gas services companies. Bumi Armada is no different. As such when valuing the company, we have to look at the normalized performance over the cycle.
However, in my reverse-engineering analysis, I did not consider such a cyclical pattern. I assumed that the past 3 years performance not only represented the future but it could be improved upon.
To give you a sense of the cyclical performance, over the past 12 years
- Contribution margin ranged from 23 % in 2016 to 64% in 2023 with an average of 53%. In my reverse-engineering model, I assumed 67 %.
- Capital turnover ranged from 8% in 2016 to 28% in 2012 with an average of 20%. In my reverse-engineering model, I assumed 23 %.
My reverse-engineering valuation of RM 0.57 per share is a very optimistic one. You can understand why I do not think Bumi Armada is an investment opportunity.
Over the past 12 years, impaired a total of RM 5 billion of assets. In my valuation, I assumed that there will not be any such costs. I think this is open to challenge if you believe in the cyclical nature of the oil and gas sector.
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Conclusion
My analysis of Bumi Armada showed that it had turned around its poor performance resulting from the low oil prices. The company's performance over the past few years had improved.
Its re-organization has delivered the results in terms of improving gross profitability and contribution margins over the past few years. Its facilities are operating at high utilization levels. It had also improved its financial position.
But this is a Group whose performance is tied to the expenditure of the oil and gas companies. This in turn is tied to crude oil prices. Over the past 12 years, there was a 57 % correlation between Bumi Armada’s EBIT and Brent crude oil prices.
I posit that the better results over the past few years were due to higher crude oil prices compared to those from 2014 to 2016. But there is no guarantee that crude oil prices will remain high. Refer to Chart 7.
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| Chart 7: Brent crude oil prices. |
In other words, I see Bumi Armada as a cyclical company. Unfortunately, the market is not pricing it as such. You can understand why I do not see this as an investment opportunity.
I have also pointed out that the Group is not operating all its vessels. There is a chance of higher revenue with this. My valuation with this optimistic picture shows a value that is close to the NTA. If you are a betting person, this could be one good bet. But this is short term view as it had not considered the “normalized” margins over the crude oil price cycle.
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Disclaimer & DisclosureI am not an investment adviser, security analyst, or stockbroker. The contents are meant for educational purposes and should not be taken as any recommendation to purchase or dispose of shares in the featured companies. Investments or strategies mentioned on this website may not be suitable for you and you should have your own independent decision regarding them.
The opinions expressed here are based on information I consider reliable but I do not warrant its completeness or accuracy and should not be relied on as such.
I may have equity interests in some of the companies featured.
This blog is reader-supported. When you buy through links in the post, the blog will earn a small commission. The payment comes from the retailer and not from you.
Disclaimer & Disclosure
I am not an investment adviser, security analyst, or stockbroker. The contents are meant for educational purposes and should not be taken as any recommendation to purchase or dispose of shares in the featured companies. Investments or strategies mentioned on this website may not be suitable for you and you should have your own independent decision regarding them.
The opinions expressed here are based on information I consider reliable but I do not warrant its completeness or accuracy and should not be relied on as such.
I may have equity interests in some of the companies featured.
This blog is reader-supported. When you buy through links in the post, the blog will earn a small commission. The payment comes from the retailer and not from you.
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