Petrosea, part 2

Some of you may already know that Mr. Lo Hong Kheng (LKH), the most famous individual investor in Indonesia, holds shares of Petrosea (PTRO) in substantial amounts, ie 65.9 million pieces of shares, equivalent to 6.5% of the total outstanding shares of the company. If LKH bought PTRO at current price, ie Rp1,290 per share, then he has invested at least Rp85 billion or about US$ 8 million in this subsidiary of Indika Group. Although these funds may be only a fraction of the total assets of him, but of course you can not call it a dime. The question is, what is so interesting about this stock?

About a year ago, I've discussed this PTRO (read here), and at the time, the conclusion was that this company is a good company in terms of operational performance as well as growth in the long term (PTRO is a coal mining services company). But on the other hand, its management was less fair by 'forcing' the company to pay interest on bonds issued by the parent, Indika Energy (INDY),  and the interest is not small compared to company’ net profit. So if we assume that PTRO net profit could be minus at any time (because of this), then the stock was not going anywhere.

Yet there is another very interesting factor of PTRO: Its current valuation, that is very low. Let's see, based on last financial statement of third quarter of 2013, and based on the current stock price that is 1,290, PTRO recorded 5.4 times of PER, and 0.6 times of PBV. Its dividend yield? In 2012, PTRO paid dividend of US$ 0.021 or equivalent to Rp230 per share (using an exchange rate of Rp11,000 per US Dollar), so that its yield, based on the current share price, is 17.8 percent!

However in 2013, the value of dividends reduced to only US$ 0.007 per share, in line with the decline in the net profit of the company. But in terms of PER and PBV, especially PBV that is only 0.6 times, PTRO remain very attractive. And for any value investor, especially bargain hunter such as LKH, these valuation factors cause PTRO too good to be ignored.

As usual, here are some points you should know about late development of PTRO, if you want to follow the footsteps of the master:

1. PTRO has a beta of 0.19, and this means that the movement of the stock is not affected by the JCI movement, almost at all, so the stock is worth to buy if you are still worried that JCI will go down further. The only stock that has a lower beta, as far as my research, is Unilever Indonesia (UNVR) with beta 0.18.

2 . Like most other coal mining contractor, PTRO recorded a 54.9% drop in net income in the third quarter of 2013, so that its ROE was down to just 11.2%. Although the performance looks bad, but the point is that the company was still able to make a profit, so that its net equity can still rose by 5.1% in the last nine months, and it has been reduced by dividends. If you’re include those who are optimistic that the coal sector will not sluggish forever as it is now, then when later the sector eventually recovered, PTRO should not having difficulties to rise its performance again, and so did the stock price.

3. In May 2013, PTRO officially received additional loans from Indika Capital Resources (ICR), which is a fellow subsidiary of INDY, so PTRO debt to ICR was rise to US$ 140 million, and this is the form of the cost transfer from INDY to PTRO (INDY issued a number of bonds in Singapore, and ordered PTRO to pay the interests). The results, in the third quarter of 2013, interest expense of debt to be paid by PTRO to ICR was rise from US$ 10 to 16 million. If there was no additional debt, PTRO net profit should be approximately US$ 23 million instead of only US$ 17 million.

The third point is that makes PTRO being risky, because Indika Group as the parent company might increase the interest to be paid by PTRO, eventually led to a significant decrease in PTRO net income, perhaps even to minus aka loss. But there’s good news: The company plans to pay some of its debts to the ICR of US$ 115 million in November 2013, so in its financial statements for the period of fourth quarter of 2013, the debt will be reduced to only US$ 25 million.

4 . But outside of debt to ICR, PTRO had fairly reasonable balance almost without any debts (there was short-term bank loans of US$ 12.5 million, but it's not a serious amount). And the most interesting is its net capital structure: From the equity amounted to US$ 197 million, US$ 163 million of which is the accumulated retained earnings of the company 's net profit in the past, while so far the company regularly pays dividends each year. Meaning? PTRO is a well-established company with a long-term track record, without the need of any help of funding, either for operations or expansions. Compare with Delta Dunia Makmur (DOID), for example, which still struggling to cope with its very, very large debts.

Lastly, and this is probably the main reason why LKH gets into PTRO, because the company has real assets with a value that much higher than the current share price. In the third quarter of 2013, PTRO had cash amounting to US$ 52 million, and restricted cash of US$ 117 million. So the total is US$ 169 million, in form of bank deposits with interest rate 6.25 - 8% per year for Rupiah deposits, and 2.3% per year for US Dollar deposits.

If we use the exchange rate of Rp11,000 per US Dollar, then PTRO have assets in the form of cash amounting to Rp1.9 trillion, all fresh in several bank accounts.

And what is the current market value of the entire stock of PTRO? Only Rp1.3 trillion! So even if we assume that PTRO is a company that will go bankrupt so its assets must be liquidated, if you buy a 100% stake at a price of Rp1,290 per share, you only need to spend Rp1.3 trillion to take cash deposits amounting to Rp1.9 trillion which mentioned earlier. So even without do nothing, you will surely make a profit of Rp600 billion or about US$ 54 million, not including profits from the sale of other assets belonging to the company.

But how about PTRO US$ 140 million debt to ICR? If PTRO sell all of its non-cash assets then pay off its debts, including that to ICR, the remaining cash would be valued at approximately Rp300 billion. For conservative approach, let say that this Rp300 billion is just dissapeared (the assets are sold at low prices, only to be enough to pay off debts), so there are cash deposits of Rp1.9 trillion only. And.. how much money you have to spend to acquire the entire cash deposits if based on the PTRO current stock? Only Rp1.3 trillion! So we have a margin of safety of at least Rp600 billion here, or equal to US$ 54 million, if you decided to acquire the entire company.

Therefore, PTRO was remarkable appealing to a value investor. The point is that if PTRO assets are non-current assets that are difficult to be sold/liquidated if something bad happens to the company (eg company went bankrupt), then its PBV that is less than 1 times may not be too appealing. But in PTRO, we have several assets that can be liquidated at any time, so at the worst case that the company went bankrupt, PTRO would still have a significant commercial value.

But as we’ve discussed above, PTRO is a well-established company without any real debts, so why it’s gonna be bankrupt?

One more thing to note is, the asset of restricted cash of US$ 117 million, which mentioned earlier, it will only be used to pay the principal of the loan to ICR (so it was called 'restricted’). So if PTRO goes bankrupt, the deposits will immediately dissapeared because it will used to pay the debt to ICR, so the remaining assets are deposits of US$ 52 million, accounts receivables, prepaid taxes, investments in several subsidiaries, as well as a number of fleet of heavy equipments. If we take this point of vie, then PTRO margin of safety may be smaller than Rp600 billion, as the company will certainly have difficulties to immediately liquidate its assets, especially its heavy equipment fleet. But there are two things to note here: 1. PTRO only need to liquidate their assets in the event of a worst case scenario, ie when the company went bankrupt, and 2. Margin of safety of Rp600 billion was likely to be reduced, but it will not be until zero, because the number of Rp600 billion was already been reduced by Rp300 billion (for conservative reason which mentioned above).

Petrosea' fleet of heavy equipments

So in conclusion, it is clear that LKH acquired PTRO for one simple reason: The stock is undervalue and offers some profit, even if we take the worst case scenario that may occur in the company. Meanwhile, if the coal sector recovers as expected, then the benefits can be many fold.

However, LKH usually will take several months to years to make a significant gain from investments, and so for PTRO, he certainly did not expect that he would be able to sell it tomorrow afternoon to earn a profit of 100%. And because he took 65.9 million pieces of shares, while PTRO shares held by public investors is only 305 million, then certainly PTRO would be an illiquid stock, especially if other investors also hod it, so PTRO is not suitable for trading. If you wish to sell it in less than 1 year, then this stuff is not for you.

But in a bearish market as it is now, there are many other stocks that are also quite appealing, especially from among the blue chips, where these stocks could going up immediately if the Composite Index later recovered, while PTRO is not necessarily do the same as its beta was very low. But since we also do not know when JCI is going to recover, or instead going lower, then PTRO is very suitable as an alternative for your investments.

PT Petrosea, Tbk.

Rating Performance in Q3 2013: BBB

Rating shares at 1,290: AAA