Basics of the Oil Services Industry That Investors Should Know – Part 2

Anyone who has been reading the papers or watched the news lately would have realised by now that the price of oil has suffered a drubbing. A real drubbing.

With the price of oil having fallen by more than half since its June 2014-peak, companies within oil-related industries have seen their share prices decline in tandem (though not necessarily at the same magnitude as the slide in oil prices).

Falling share prices bring with them the possibility of bargains and this is pertinent for local investors because Singapore happens to be home to many of the region’s largest oil services companies.

But before we can sieve out the wheat from the chaff, it might be wise for us to take a step back and understand the basics of the oil services industry.

The types of companies

In Singapore, there are mainly two types of oil services companies: The builders of rigs and ships; and the ones which provide offshore support services. This article will go on to cover more about the latter group; you can read about the basics of the rig builders by jumping in here.

Companies such as Ezra Holdings Limited (SGX: 5DN) and Ezion (SGX: 5ME) are good examples of offshore support services providers.

The basic business model of Ezra and Ezion is quite straight forward: They would build or purchase offshore assets – such as rigs, barges, subsea construction vessels, and other types of Offshore Support Vessels (OSV) – and then rent or charter these assets to companies in need of them (Ezra and Ezion’s clientle are typically companies which explore and produce oil & gas).

With these, you can see that Ezra and Ezion’s business is not unlike that of a car rental company.

Purchase price

So what is important here when it comes to the providers of offshore support services?

Like any company which focuses on buying assets for the purpose of renting them out later – be it properties, or cars, or OSVs – one of the key factors in determining how lucrative the rental business will be is the price paid for the assets. Purchasing assets at attractive prices will ensure that a company will be able to enjoy a reasonable return even when there is a downturn in its industry.

As asset prices in the offshore support services space tend to fluctuate with prevailing charter rates (more on charter rates soon), investors can track a company’s buying and selling of assets to gain a better understanding of management’s capital allocation skills.

If management is aggressively buying new assets when charter rates are climbing rapidly then failing to buy when charter rates fall, it could be a sign of poor capital allocation skills on the part of management.

In a similar way to stock market investing, managers of offshore support services providers should be fearful when others are greedy and greedy when others are fearful.

Charter rates

As promised, here’s more about charter rates.

The charter rates not only reflect oil prices, but also the current supply and demand dynamic for assets used in the provision of offshore support services. A downward trend in charter rates might be telling investors that the demand/supply situation is deteriorating for a company.

Balance sheet

Although the macro-economic conditions of the offshore support services industry is important for investors to note, the micro-economic conditions of individual companies in the industry-space should also be taken into consideration. One particularly important micro-economic condition would be the strength of a firm’s balance sheet.

In a similar manner to the rig builders, offshore support services providers are also in a cyclical business and should maintain a strong balance sheet in order to withstand downturns without being weakened.

For the case of Ezra and Ezion, both seem to be quite similar in terms of the strength of their balance sheets as they are both carrying total debt to equity ratios of around 130%. Having similar strengths need not mean that they are strong though, as a total debt to equity ratio of 130% is not exactly a sign of a strong balance sheet.

In any case, Ezion seems to have some room for error given that it has an EBITDA to interest expense ratio (a measure of how easily a firm can service its borrowings; the higher the ratio, the better) of 13. Meanwhile, Ezra finds itself with much less room for maneuverability as its EBITDA to interest expense ratio is only 3.

Foolish Summary

Do bear in mind though that both Ezra and Ezion have other businesses other than the chartering of assets for offshore support services.

But that said, both companies’ various lines of businesses are still generally related to the oil services industry. So, it won’t be a surprise if both companies’ businesses deteriorate due to the current slump in the price of oil.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn't own shares in any companies mentioned.