CSE Global – Riding on crude oil recovery

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Founded in 1985 as the engineering projects division of Chartered Electronics Industries, the electronics arm of Singapore Technologies (ST). CSE Global is one of the few qualified system integrators in the region for the oil and gas (O&G), mining and communications infrastructure industries. The company has operations in Asia Pacific, the Americas, Europe, and Middle East.

Strengths

A distinct competitive advantage is CSE’s close working relationship with blue-chip
customers such as Shell, Exxon Mobil and a 32-year track record in the business.

Another key advantage of CSE against its peers is the inventory-light model where CSE sources third-party technology for system integration projects.

With over 1000 engineers and technicians, CSE’s technical engineering expertise and solid track record is a natural entry barrier giving a “competitive edge” for the business. The strong technical know-how has allowed CSE to enjoy health margins while new entrants with little or no track record struggle to compete.

When CSE wins contracts for system integration projects, it is highly likely to benefit from subsequent upgrading and maintenance works. In 2017, an estimated 63% of total revenue was attributed to upgrading and maintenance works.

As a result, CSE benefited from customer stickiness and provides competitive pricing and cost effective solutions to its customers.

Weaknesses

In comparison to a decade ago, when most of its revenue came from offshore O&G, the group has expanded its reach to serving transport, power utilities and waste water utilities companies.

Despite that, The group’s revenue exposure is still relatively concentrated within the O&G industry contributing 70% of group revenue in 2017. CSE is still perceived as a pure-play O&G company.

Recovering from Poor Performance in FY17

FY17 CSE reported net loss of $45.1mil while gross margins in FY2017 reduced to 26.0% compared to 31.7% for FY2016.

This was mainly attributed to weaker oil & gas margins, margins were low at an estimated 4% (vs. 3Q16: 5.7%). Management guided for margins to stay low, at least till FY18F, due to the competitive tendering environment.

Management also highlighted that the lack supply of large greenfield oil & gas contracts in 4Q17F.

For FY18, the group outlined plans to recover from its loss making year:

  1. Revitalizing its existing solutions and services, improving delivery and new applications.
  2. Adding new solutions and services.
  3. Retaining and maintaining existing customer relationships.
  4. Adding new customers.
  5. Cost control and cash generation.

Quarz Capital sends CSE an open letter

On the 26 Feb 2018, shareholder Quarz Capital sent CSE Global an open letter with a
series of recommendations:

  • Recommendation 1: Immediate distribution of S$18m.
  • Recommendation 2: Commit dividend payout of 80% with a dividend payout floor of S$12.5m.
  • Recommendation 3: Target ROE of >10%, which can be achieved via right-sizing CSE’s US business, integrating subsidiaries/new acquisitions, reducing corporate expenses, and targeting future growth opportunities.
  • Recommendation 4: Seize growth opportunities in structural growth areas, such as the infrastructure segment in Singapore and Australia.
  • Recommendation 5: Increase alignment of board, top management and shareholders’ interests (via transparency between board and top management’s compensations with total shareholders’ return; and via increasing the proportion of share-based compensation which will vest over the mid and long-term). CSE guarantees dividend for 2018.

Post meeting on the 5 Mar, CSE agreed to a few of Quarz’s recommendations:

  • Firstly, it gave a clear guidance of 2.75 cts DPS for CY18. This implies a dividend payout ratio of 94.4%.
  • In addition, CSE committed to continue the rightsizing and turnaround of CSE’s
    existing US business with the goal of achieving higher profitability in 2018, and
    provided a long-term target return on equity of >10%.

In 2Q18, CSE reported stronger revenue of S$92.1m vs 2Q17 revenue of S$85.5m with slight increase in gross margins.

CSE highlighted that they are optimistically cautious as clients remain focused on cost control, but expects GPM could stay stable at 26-27% in FY18F.

Opportunities

1.Expansion in the US.

The group remains positive on its O&G business, which is gaining momentum on small order contracts. Compared to large orders, the smaller orders are highly recurring in nature and generates higher net margin. As management looks to expand its presence beyond the Permian Basin and Eagle Ford, earnings growth momentum should be sustained with greater order intake and growing order-book.

In the recent quarter, the Group continues to secure new orders from greenfield (new installations) projects and brownfield (maintenance, upgrade and enhancement of existing installations) projects totaled S$89.1 million, ending the quarter with an order book of S$148.8 million.

cse-orders

2.ANZ Growth potential.

CSE expects steady demand from customers in Australia and intends to grow its dominant position as a nationwide player in the 2-way radio communication infrastructure industry. There is also scope for CSE to expand its presence in the 2-way radio business to New Zealand when presented with the right opportunities. On the other hand, CSE is bidding for several sizeable infrastructure projects worth around S$30m.

CSE’s radio communications businesses in Australia has so far contributed S$42 million revenue in FY2017, which is a significant progress from the S$5 million revenue
in FY2015. This was achieved through partially organic and inorganic acquisitions of 5 companies in Australia. CSE had grown 68% over 3 years in its infrastructure business revenue, from FY2015 to FY2017.

3.Exploring synergies with Serba Dinamik for Petronas deal.

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In 1Q18, Serba Dinamik acquired over 128.2m of CSE shares from eight shareholders for S$57.7m (0.45 Scts/share).

In line with its focus to service its existing base of customers and exploring opportunities from its current operations, CSE announced plans to explore synergies together with Serba Dinamik.

With an eye on expansion across Malaysia and North America, CSE is working in partnership with Serba Dinamik (Serba) to become an approved service provider for Petronas. Meaningful developments within this space are expected to flow through within the next 12 to 18 months.

4.Management’s bet on recovery.

Since May 18, the group has been buying back shares at an average of S$0.47/share, indicating management’s confidence in the company. Riding on strong industry rebound, CSE remains undervalued at 11.0x 2019F PE with ~16% of its market cap in net cash despite a consistently profitable business.

Macro Outlook

WTI

Capex spending in deep offshore O&G business is highly dependent on oil prices. The recent surge in crude oil (WTI & Brent) would certainly boost capex spending from the oil majors.

With OPEC recently declared that it has no plans to increase output and geopolitical tensions surrounding Iranian production, falling production in Venezuela and volatile Libyan exports continue to weaken global supply base. Additionally, short-term pipeline capacity constraint in the Permian Basin is threatening to cap production growth.

Schlumberger and Baker Hughes – two of the largest oil and gas (O&G) service companies globally – both see a pickup in the offshore sector, as customers go ahead with large projects that were delayed since 2015. After the deepest downturn in 30 years where capex declined by 40% over the past 3 years, the recovery in sentiment could lead to an increase in capex, which is expected to grow by 15-20% in North America and 5% internationally.

Key Risks:

  • As we have seen over the past few years, CSE’s performance is very much dependent on oil prices. Weak oil prices will dampen spending from the oil majors leaving only smaller projects for tender.
  • Credit risk exposure to commodity related customers, the recent selloff in commodity prices led to mass bankruptcy of commodity producers and explorers. Ongoing projects with financially unstable customer may lead to defaults of payments.

Price catalyst:

  • Large O&G contracts wins.
  • Accretive acquisitions in communications infrastructure industry.

 

Sources: UOB research, CSG-CIMB research
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