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Investors Beware – All May Not Be Well At Nam Cheong Ltd

Offshore support vessels builder Nam Cheong Ltd (SGX: N4E) seems to have been hit hard by the sharp decline in the price of oil over the past year.

In the first nine months of 2015, Nam Cheong saw its revenue and profit record year-on-year falls of 50% and 81% to RM708 million and RM50 million, respectively. Meanwhile, the company’s operating cash flow for the same period also fell sharply from a negative RM20 million a year ago to a negative RM591 million.

Additionally, Nam Cheong’s accounts receivables and inventories had both grown. The former had jumped by 60% since the end of 2014 to RM780 million as at 30 September 2015 while the latter had increased by 57% to RM1.6 billion over the same timeframe. A situation of declining sales coupled with growing accounts receivables and inventories can be a yellow flag for more potential problems ahead.

That’s not all. Nam Cheong ended the third-quarter of 2015 with more than RM1.9 billion in debt. As the table below illustrates, the company’s net-debt (total borrowings minus total cash) to equity ratio has shot up from just 41.5% at the end of 2014 to 95.5% in the latest quarter.

Time period Net-debt to equity ratio
31 December 2010 78.2%
31 December 2011 62.9%
31 December 2012 38.1%
31 December 2013 52.0%
31 December 2014 41.5%
30 September 2015 95.5%

Source: S&P Capital IQ

All these financial troubles, likely due to tumbling oil prices, have pushed Nam Cheong to a situation where it is close to missing a financial covenant set by some of its creditors in that its interest coverage ratio shall not at any time be less than 3:1 (covenants are terms set by creditors that borrowers have to fulfill).

With its deteriorating financials over the past twelve months, Nam Cheong had launched a consent solicitation exercise this morning to seek consent from some of its bondholders to amend the aforementioned financial covenant. The company also hopes to get approval from the same set of bondholders to waive any non-compliance, or potential non-compliance, of the covenant for the test period ended 31 December 2015.

Although the solicitation exercise might not signify that Nam Cheong is facing any bankruptcy risk, it does show that the company is currently caught in a situation of having high debt but falling revenue which it did not anticipate previously. And for me, this says a lot about the risk management ability (or perhaps, lack thereof) of Nam Cheong’s management team.

There are other pressing issues at hand for Nam Cheong. If oil prices do not recover soon, the company may likely continue to produce negative free cash flow from its business. Moreever, even if the ongoing consent solicitation exercise is successful, Nam Cheong might still face serious refinancing risks going forward given that it has S$365 million worth of bonds coming due by 2019. These are things that both current and prospective investors in the shares and bonds of Nam Cheong may want to keep in mind.

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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 above.