Is There More Pain Ahead For SembCorp Marine Ltd?

Oil rig builder Sembcorp Marine Ltd (SGX: S51) had released its fiscal fourth-quarter earnings (for the three months ended 31 December 2015) just two days ago on Monday evening. It was ugly.

The company reported an 8.2% decline in quarterly revenue compared to a year ago. And as a result of impairments and provisions of S$609 million for the quarter – over half of which are linked to the company’s embattled Brazilian customer Sete Brasil – Sembcorp Marine had logged a loss of S$537 million for the quarter. It was the first time the company had suffered a quarterly loss in 12 years.

Interestingly, shares of the company had jumped by 7.5% to S$1.57 on Tuesday and is currently sitting on a 3.5% gain at S$1.62 as of the time of writing (3:04 pm). According to a Business Times article published yesterday evening, Sembcorp Marine’s shares had climbed after rumours that the firm may be taken private surfaced.

But while the share price gains for yesterday and today have provided some welcome respite from the unrelenting slide that has seen Sembcorp Marine’s shares lose 51% of their value in the year through 15 February 2016, what investors may want to focus on now is this: Is there more pain ahead for the company?

Unfortunately, there are signs pointing to possible problems ahead for Sembcorp Marine’s business. As mentioned, Sembcorp Marine’s revenue in the fourth-quarter of 2015 had slipped by over 8%. But, the firm’s total receivables had actually grown by 25.9% from S$468.5 million at end-2014 to S$589.7 million at end-2015.

Receivables are found in the assets portion of a company’s balance sheet. In general, when a company builds or sells a product to a customer, payment need not necessarily have been received by the company yet. That promise to pay by the customer is what makes up the receivables.

When a company’s receivables is growing at a much faster clip than revenue, it may be a sign that the company’s having a tough time collecting payments from customers in a timely fashion. The company may also have been forced to extend looser credit terms to its customers in order to keep its business going. There can be more issues at hand, but these two are some good examples.

Coming to Sembcorp Marine, its disproportionate growth in receivables is very likely due to its customers being in distress themselves as a result of the drastic fall in the price of oil from over US$100 per barrel in mid-2014 to around US$30 today. In Sembcorp Marine’s latest earnings release, the company gave clues to the situation (emphasis mine):

Several of our customers have requested for delivery deferments in light of delays in chartering out their rigs. Given the current depressed environment in the upstream sector, we have tried to accommodate their requests, while preserving our commercial interests. As has been reported, one of our customers has failed to take delivery of its rig, and we have terminated the contract and taken legal action to recover the amount due to us.

For the rest of our completed rigs with deferment requests, they have all been technically accepted by our customers and we have arrived at or are finalising mutually acceptable solutions with them.”

Having large spikes in receivables could result in cash flow issues for Sembcorp Marine (the company has to spend money to build rigs that payments may not have been made for by customers yet). That wouldn’t be a big problem if the company has a strong balance sheet. But unfortunately, that’s not the case at the moment.

In fact, as of 31 December 2015, Sembcorp Marine’s balance sheet is at its weakest over the past decade based on the net debt to equity metric. In the chart below, you can see how the company’s net debt to equity ratio had climbed over the years to 103% at end-2015.

Sembcorp Marine's quarterly net-debt to equity ratio since last-quarter of 2005
Source: S&P Global Market Intelligence; author’s calculations

Disproportionate growth in receivables and a deteriorating balance sheet can be a toxic combination for a company. They are by no means a guarantee that Sembcorp Marine will run into even tougher times ahead, but they are risks that prospective and current investors in the company may want to think hard about.

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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 Chong Ser Jing doesn't own shares in any companies mentioned.