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Saturday, 30 May 2009

I bought CH Offshore on 25th May 2009

Before I go into the rationale behind my purchase, I will like to share some thoughts on the oil & Gas industry (from the investment context) and value investment in general. I had quite a fruitful discussion on the above topics in one forum thread and exchange of comments with a reader on my blog entry when I purchased SPC.

Oil & Gas Industry from an investment point of view

The first thing that came to mind when one discussed about the industry is crude oil price. As far as investment is concerned, unless one buys a crude oil index exchange traded fund (ETF) or equivalent, using crude oil price as an indicator is not so straight forward.

The meaning behind crude oil price

It is quite easy to miss the forest for the trees. Once the crude oil price surge, the immediate sentiment is that oil and gas industries must be making money but this is not so. Crude oil price is just a barometer for supply and demand. Whether emotional, speculative or real, it just signifies meeting point between them. And it is that simple.

Oil and gas activities can be divided roughly into 3 categories:
  1. upstream (oil and gas exploration and production)
  2. downstream (crude refining)
  3. support (offshore support, rig manufactures etc)
When real or anticipated demand exceeds real or anticipated supply, oil price surges and vice versa. The movement of the supply and demand curve moves the crude price and had varying effect on players in the above 3 broad categories. Note that demand and supply curve (whether real or emotional) must move first before crude oil prices barge.


Players in oil & gas exploration and production players are the first to benefit when price surge and first to suffer when price plunge (especially so when price plunges below production cost, i.e.

Profit = function (crude oil price)


Players are mostly refiners who use crude oil as raw material and sells refined products. Their profit are heavily dependent not on crude oil price, but crack spread (the profit margin between crude and refined oil). Most of the people I talked to focus on this, but that is only part of the picture. The next part is demand. Profit is a function of sales volume and profit margin:

Profit = function (crack spread, sales volume)

Downstream players are more sensitive to crack spread and sales volume rather then crude price. When economy is booming, the demand for crude generally rises (emotionally or real) more than supply can keep up. The effect is rising prices. The crack spread might suffer, but profit can still go up if the increase in sales volume more than make up for the declining spread. Problems arises when the crude price surges to a point that affects demand, then both sales volume and crack spread drops and hurt profitability. It is these dual factors that gave people the wrong impression that profitability of refiners had nothing to do with crude oil price. It does, but indirectly via demand and supply curve instead.


Support players are very much affected by crude prices but lags crude price cycle a big deal. When the economy starts booming after a recent recession, it will take some time before demand catches up again with supply. It will take even longer before crude price surges again to a point that makes oil and gas exploration or extractions lucrative. Further lengthening the cycle is that support projects typically have long gestation periods. It takes many months to build support vessels or oil rigs and sustained efforts during exploration. Activities can persist for months after oil bubbles burst.


Thus, once the euphoria for oil and gas industry subside with the collapse of the oil bubble, I believe there are opportunities to look for bargains. First, I bought SPC, now I bought CH Offshore. The former is a typical refiner (though it has some exploration and production segments) and the latter is a typical support player. Compared to other companies (such as Ezra and Swiber) operating in the support segments, CH Offshore stands out with its less (nearly none) leveraged business model. The downside is its growth will not be as speculator during the upturn. I could have got it way cheaper a few months ago, but alas spare cash don't come easy these days.

A few words on Value Investing (and fundamental analysis)

From the forum discussion, it becomes apparent that some believers of value investing would ignore cyclical businesses because they find them hard to value. Value investing preaches buying things below their intrinsic value with sufficient margin of safety. Intrinsic value is an estimate. Just because cyclical businesses's intrinsic values are difficult to ascertain due to the highly fluctuating profits and losses does not mean value investing cannot be applied.

Look at it another way. Highly cyclical businesses have such huge peak to through fluctuations in earnings (and hence share price) and these fluctuations are recurring in nature. Hence, the magnitude in the fluctuations safely assumes that purchases near the through when a cyclical sector collapses (not price bottom since one cannot predict the bottom) should provide the sheer margin of safety.

It is for this reason I bought Courage Marine when BDI crashes below 800 when I believe the shipping bubble had more or less burst.


There are always many routes to a destination. Some are more established while some are less travelled. By sticking only to the established route, one misses out the many hidden opportunities that could have been better.

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Saturday, 23 May 2009

Matrix for Personal Finance Planning


As I was working on a long term planning project, I came up with a matrix to put various initiatives in perspective. It suddenly dawn on me that I could apply that matrix I developed to personal finance planning. I promised my friend to blog on it, so better keep my promise :).

Personal Finance Planning Matrix

The above shows the personal finance planning matrix I've created for a typical, non-financially independent individual like myself, still slogging to make ends meet. Basically, annual income can be spent or set aside for future use. Spending is typical a reaction to a need or want and hence 'reactive' versus saving where money is set aside for future use, i.e. pre-empting future rainy need.

Risk provides another dimension to consider when spending or saving. Merely spending on needs make life boring and meaningless while merely savings lose out to inflation. Thus inducing the individual to pamper oneself with some discretionary spending on wants. For the more adventurous, dabbing in some investments for higher returns.


Before one consider how much to spend, to save or to invest and much is enough, how much is too much, one could consider using the matrix above to put things in better perspective. The following shows a annual budget profile for an individual, drawing some 14 months salary during a typical, non-recession year:

By looking at his or her profile, one can easily come to conclusion whether he or she is comfortable with the distribution, in terms of months of annual salary actually used in each section.

One potential contention or confusion is differentiating between 'need' and 'want'. Since each individual have different value system (i.e. what is important to one may not be important to another person), differentiating between needs and wants need not be a painful exercise, just allocate things one can do without into wants.

How much is enough?

To answer the question of under or over allocation in each section, one can take a stock of his or her current status:

The above chart assumes an individual currently had 6 months of savings and 12 months worth of investment (current liquidatable value equates 12 months of gross salary). Thus in times of crisis (loss of job or can't work), he or she can easily survive more than a year (assume investment value plunges by about 50%). But is this enough? With his or her financial profile visible now, it is up to the person to decide. e.g. "am I comfortable with 6 months savings?"

Setting a target

One can now set a long term, say 10 years, target of his or her financial position:

By saving only 2 months of salary (and not spending from that pool of funds) and investing only 1 month salary, the accumulated pool amounted slightly over 3 years (assuming investment give about 5% annual returns).

Assuming the individual is not satisfied with the above 10 year situation, one can easily set a comfortable target in terms of accumulated savings and investment and work backwards, invariably having to spend less and save/invest more.

Where to place insurance?

A few (several) words on insurance before I close this article, I see insurance as a service to help one take care of unforeseen financial consequence one is unwilling or unable to afford. Thus if it is a service, it must be an expense. If such a service is a need, then it should go into the 'needs' spending section. However, one point of contention arises because today's insurance products are typically very much convoluted with investment components. Investment is a pre-emptive product meant to generate returns for the risk involved.

The fact that many life policies provides insurance coverage (expense) yet provide surrender value above total insurance premiums paid over the years (returns) once the policy matures, depends heavily on investment returns that is far from certain. The underlying assumption is that the investment component of the life policy generates sufficient return to cover insurance expenses (insurance company's expenses + insurance agent's commission) and insurance premium paid by the person assured. When the investment component does not perform as well as planned, the assured will be quite disappointed to learn his or her policy have not 'break even' after paying the premium for decades. It would have been better to separate the two, i.e. buying term policies and investing the 'excess' premium separately.

In conclusion

It is quite difficult to plan one's route or know where one's going without a map. The matrix above provide such a map to locate oneself, and the destination one hope to go, and plan the route accordingly. Charting for myself, I'm happy to see my current location and see that I'm going in the right direction. Hope this is helpful for you too.

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Wednesday, 6 May 2009

I bought Soup Restaurant on 4th May 2009

Rationale and Action

This is the first time I bought something not for investment, or rather, investment is not my primary concern. My wife like the food very much and I just came across its announcement on 30th April 2009 about Shareholder privilege card scheme, i.e.15% discount for shareholders with at least 2 lots.

Investment grade?

As for investment assessment, I have my reservations. Unless it have a strong franchise potential (which I can't see), I think it'll be like any other restaurant business that will have difficulty generating sufficient value above cost of capital for shareholders.

More on the card

To get the discount card, one need to fill a form to proof ownership of at least 2000 shares by disclosing ones' CDP account number. I presume they'll check it there. However, once I get hold of the discount card, I can't think of a way to verify I'm still a shareholder the next time I dine at Soup Restaurant. The staff at Soup Restaurant can't be checking with CDP everytime a customer produce that discount card right? So what is stopping anyone from buying 2 lots, get the card and sell it off?


This post is short. This blog is my diary so might as well pen this down for future reference. Anyway, I got hold of some 12 lots just in case Soup Restaurant proof me wrong and is able to create more value than I think possible. Look forward to my privilege card :)


Monday, 4 May 2009

First Ship Lease Trust's Distribution Reinvestment Scheme (DRS)

DRS Summary

In short, DRS is a scrip dividend scheme for FSLT to make payments through issuing new shares in place of cash. FSLT had 2 strategies to reduce cash payout in terms of dividend, one is via direct reduction in distribution (from almost 100% to 75%) and second is via DRS. While a 25% cut in direct distribution conserve about USD 4m, how much DRS can conserve depends on the take up rate, up to a potential conservation of about USD 12m. To entice shareholders to take shares instead of cash, the shares are offered at a discount of about 5%.

Shares or Cash dividend?

I had an enjoyable discussion on the topic with a reader and the our correspondences (via comments on one article) can be found here. After the fruitful exchange with better insight, I summarise the key points and add a few more.

Qualitatively, if the market ultimately recover (before 2012 when the first bullet payment is due), choosing shares might seems a better option. But in current market sentiment where cash is king, many might choose cash that is immediately tangible. If the shares crash further, the cash can buy more units than those offered at a discount under DRS.

Those who should know better

Is there other hints for a better decision? The management and the sponsor should hold the key to the answer, if they don't know, who would know better? Along with the annoucement on the discounted price of the new shares under DRS, the take up rate of the key directors and sponsors are disclosed as well. If all of them subscribe 100% to new shares, I would almost do the same without much thought. In contrast, if the unamious choice is cash, I'll take cash and run fast. However, shareholders looking for a mark of confidence is still disappointed. The key directors take up 100% while the sponsor choose only to take up the 25% of the distribution in shares. 'Insiders' show their confidence, sponsors shows their reservations.

Quantitative Analysis

So qualitative analysis doesn't help here. How about quantitative analysis? The following is table tested the outcome if I choose shares entirely while 25% of other shareholders choose shares.

Under this scenario, my dividend entitlement for the next distribution will rise by about 7.2% to compensate me for taking shares instead of cash now. This compensation will fall to a meagre 2% if all shareholders take up distribution in shares. (Note that the actual DPU falls by 2.5%. The fall is even larger at 7.2% if all choose shares).

Over a longer period, until 1Q 2012 when the first bullet payment is due, the comparison for taking shares all the way versus taking cash all the way is illustrated:

Here, I assume the DRS only applies until 3Q 2010 when the USD 65m tranche is due for first installment (the distribution cut to 75% should be enought to service this installment) and dividend continues until 1Q 2012 when the 1st bullet payment is due. It is quite clear that taking shares might be a more worthwhile option, provided the shares are still worth something by 1Q 2012.

Benefits to FSLT

I've been talking from common shareholder's point of view. How about from FSLT? Cutting distribution to 75% generated about USD 4m and assuming all shareholders take up shares, will yield another USD 10m (the sponsor already pledge to take up 25% distribution in shares). But against the loan of some USD 500m, it might seems meagre. Noting that one of the value-to-loan covenant is 145%, a USD 10m reduction in debt will improve value-to-loan ratio by about 3.5%. But the expected reduction will be much lower since I don't think most shareholders will opt for shares.


I'll take up shares for now and see how other shareholders react. In the long run, I'm still confident that if the management can make use of the (slightly) better financial position to improve distribution in the future (via more distribution accretive acquitisions), it is still better to take up more shares.