Nam Cheong – What you need to know before investing in it?

Nam
Cheong share price
peak to S$0.45 this week following two announcements of US$176mil
contract wins in a space of less than two weeks. Nam
Cheong’s order book now boasts 25 vessels worth about RM1.7 billion.
See
announcement
here. A month ago Nam Cheong share price is still trading at S$0.38. Last
close price is S$0.44 representing >15% increase within a month. 

What is
Build-to-Stock Business Model?
An OSV typically takes 12-24 months to complete building. Many O&G
projects may require OSV owners to have ready vessels to work within a much
shorter time-frame. The mismatch in shipbuilding time and actual project
requirement means that OSV owners can tap on Nam Cheong’s build to stock
business model where vessels were built in advance before the actual project
taking place. This help to considerable reduce the delivery time for their
clients.
Build-to-Stock (BTS) Pre-requisites
Nam Cheong is require to know which Oil and Gas projects in preliminary bidding stage and who are the OSV players tendering for which specific projects. The
need to plan what type of vessels to build, and at what time to build, requires
Nam Cheong to have a extensive knowledge of the market and its
requirements. In a recent interview from “Business Times”, Nam Cheong CEO
mentioned that having comprehensive knowledge of the OSV market is imperative
for them. Their in-depth knowledge and cutting edge engineering capabilities
have also helped them to identify the most appropriate vessels to construct for
their clients.
High Margin, High Risk
BTS Model
The BTS model enables Nam Cheong’s vessels to command a premium pricing.
Nam Cheong is considered to be one of the largest suppliers of shallow water
OSVs in the world today. Albeit higher return, its business model contain higher
risks as well. The inherent risk is cash. To build a vessel upfront before a
certain sale date requires financing support, increasing leverage throughout
the process.
Today, bank only lends with a contract backed vessels. Notably, cashflow problems claim victims such as Jaya
Holdings
, Drydock World, Otto Marine during the Global financial crisis (GFC) in 2008. During the crisis, oil price takes a
plunge, many projects were cancelled and credit institutions tightened their
lending. Fearing default payments, equipment suppliers added additional
pressures to shipbuilders with a “no payment no progress” stipulation.
Sandwiched between cancelled projects from clients,
non-deliveries from suppliers and no-support from banks, companies who indulge
in speculative building such as Nam Cheong, Jaya, Drydock World, Otto Marine
are badly hit during the GFC.
From above chart, we can see that Nam Cheong order wins take a huge dip to less
than three vessels in 2009.

In the same period, Jaya seen its share price freefall from S$2 to 20 over cents and
acquired cheaply by Deutsche bank. Otto Marine still suffers from the
repercussions of the cancelled orders of four VS491 ultra-large AHTS today.
Drydock World filed for court protection in its financial re-structuring
process and was eventually sold to Kuok group.
How to Mitigate Risk
Proven Vessel Design in the shallow water segment
With a good understanding of the shallow water market segment, Nam
Cheong mitigates risks by only building OSVs with a broad market appeal, certified
by international class society such as ABS, DNV, GL etc. Their vessels also includes
more simpler and standardized designs such as
5150, 8000, 10,800 BHP AHTS, 300men AWB, 3000DWT PSV, ERRV etc. This is also one of
the reasons why it manages to sold off the stock vessels after the crisis. In
comparison, Otto had great difficulties selling off the four ultra large AHTS
cancelled by its Norwegian investor Mosvold shipping. Jaya also suffered from its inability to sell off its more
complicated high value OSVs then. 
Strong Customer Relationship
To bid in Malaysia Petronas projects, you are require to have the “Petronas
license to bid”. Being located in Malaysia with a many repeat clients such as
Bumi, Perdana, Nam Cheong is benefitting from the local content requirement.
Since 2007, Nam Cheong already sold 17 vessels to Bumi and 12 vessels to
Perdana excluding the recent 2 x AWB. This is the kind of “Kampung bond” you
will still find in Malaysia today. Of course the primary driver is still
Petronas huge Capex plans going forward. Nam Cheong also established a
solid client relationships with International OSV players. They are Tidewater  (one 
of  the largest  OSV  owners  in 
the  world),  Europe-based  Vroon 
and  Middle East-based Topaz. In
2012, the group entered South America and West
Africa markets.   
Support from PRC Outsource Shipyards
Nam Cheong BTS business make up >70% of its revenue today. Most of
the vessels were outsourced to China yards in Fujian – Fujian Southeast,
Fujian Mawei and Xiamen Shipbuilding. The outsourcing strategy allow it to have
more free cash flow in its speculative new builds. It also put the risk of the leverage
to the PRC yards instead. Nam 
Cheong  generally  pays 
30%  upfront  and 
70%  on delivery  for 
its  newbuilding  programme. 
Hence, the PRC yards are actually financing the construction of the vessels.
Nam Cheong’s low operating leverage is reflected in its selling, general and
admin expenses, which averaged 6% of sales over the past three years.  
Why Fujian shipyards?
Nam Cheong’s Chairman, Datuk Tiong Su Kouk is the Honorary Life President
of the World Federation of Fuzhou Association and has his roots in Fujian
province in China with exceptional good relationship with the Fujian local
government. Today Nam Cheong is one of the biggest investors in the province
with all the vessels built there over the years.
Another thing you may
not know is “People with Fujian Roots value relationships and display great
loyalty to their close ones”. I have roots from Fujian too!  Hehe!
Efficiency due to Repeat Vessel Design
Unlike other PRC shipyards that often have quality and timely deliveries
problems, these three yards are very specialized in its shipbuilding programs
and often produce vessels of much higher quality and very timely deliveries.
The reason is simple. Since Nam Cheong only build a niche of vessels in
the shallow water range, these shipyards tend to only build “Repeat Design”
vessels, and “Practice
Makes Perfect
!” since Nam Cheong had
chunked out a remarkable more than 50 vessels from these Chinese yards.
Why OSV Owners not
order direct from PRC yards?  
Most of the China PRC yards are state-owned and do not or cannot
undertake speculative builds. This is one major reason why OSV owners choose to
go through Nam Cheong rather than directly approach the PRC yards. Moreover Nam
Cheong has an experience team of project and design staffs located in Singapore. Being located in Singapore offshore hub, means
direct access to International clients and major equipment suppliers, with
better communication channels compared to PRC. In addition, Nam Cheong maintains
a supervisory project teams on the ground to manage the shipbuilding process
and ensure its quality and timely delivery. By buying direct from Nam Cheong,
OSV owners does not have to bear the construction and financial risk and hassle
of project management in dealing directly with PRC yards.
How Nam Cheong Weathered GFC and Recovers so Quickly
Fundamentals of Oil and Gas industry
The fundamentals of the oil and gas industry were sound even during
the GFC of 2008-09. To me the chaotic situations in 2008/09 are a combination
of over-optimism in the O&M industry and the
finance-tightening by credit institutions.  


From the above charts, we can see that in fact vessel sales did not stop during the GFC. Companies like Nam Cheong and Coastal Contracts (M’sia) is
maintaining its revenue growth in years thereafter.
Effective BTS strategy
Having already mentioned earlier, Nam Cheong BTS model effectively
transfer the risk to the Chinese yards. During the crisis, demand of vessels is
low but Nam Cheong simply orders fewer vessels from the PRC yards and does not
have to bear the cash operating costs and depreciation charges unlike Otto
Marine and Jaya Holdings who build vessels in their own yards in Batam and Singapore.
Strong Relationship – Clients, Shipyards & Suppliers
It is widespread knowledge in the industry what Nam Cheong treats its
business associates with respect and trust for the benefit of all. Probably
from the roots of its Chairman Datok Tiong, they also value loyalty and
friendship aside from pure business reasons. This is one of the reasons why it manages
to have 67% of its business from repeat clients. Beside its clients, Nam Cheong
also maintains a group of loyal suppliers, based on long term working
partnerships. This is unlike other shipbuilders who only select the yards or
equipment suppliers solely from a profit point of view, changing from one supplier
to another frequently. It is this loyalty of Nam Cheong that trades many return
favors from suppliers, lending them support in cashflow, to tide through the most
difficult periods of the GFC.
Rolf’s Views

I like the fact that Nam Cheong is able to recover so quickly from the
GFC. This is even at the back of achieving remarkable growth of more than 40%
yoy since FY2011.
The lesson from GFC also means better adaptability in case of
unprecedented events happening again. 
Even if there are adverse market impacts resulting from lower OSV
prices, such a situation will have a delayed impact (1-2 years) on revenues and
earnings.
Till date, I cannot find any other companies in the world that has
similar the niche. Nam Cheong BTS business model though risky is very well
managed with proven track records even during the crisis.
Below is Nam Cheong stellar performance for the past few years. 

Source: Nam Cheong
website
 

Nonetheless, the risk of BTS is still eminent. Nam Cheong business will not be spare from a sudden change
in macroeconomic landscape resulting from depressed oil and OSV prices and an unprecedented
credit crunch.  

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