Singapore Petroleum Company (SPC) is a Singapore-based oil company. Its principal activities consist of refining services, exploration and production. SPC’s core earnings driver is its refining business, making up 98% of its sales revenue. It provides oil products primarily to the Singapore market. It is also the dominant jet oil supplier in Changi Airport. Exploration and Production (E&P) forms a mere 2% of its entire business. In order to increase their regional footprint, they acquired Bohai Bay Blocks, China, Oyong and Kakap Blocks in Indonesia in 2007. SPC’s corporate strategy is to expand its E&P business by further investing in oil and gas producing assets, while developing the existing acreages. This would enhance shareholder value and ensure long term growth.
Source: Company Data Source: Company Data
The oil refining industry poses high barriers to entry and exit due to the high capital investment required. Thus, this industry is oligopolistic in nature and is dominated by only a few large players. In fact, much of the energy industry is ruled by large, vertically integrated oil companies. These companies look after all factors of production, refining and marketing.
The refined oil products market is boundless: companies can set up refineries and sales outlets in other countries to increase their distribution network. As Singapore’s only home grown oil refiner, SPC faces little competition in the domestic market.
In terms of market capitalization and business activities, SPC is a small player in the regional market. Its most comparable competitor in the Asia-Pacific region is Cosmo Oil, a Tokyo based oil refining company. Other competitors include Royal Dutch Shell (Shell) and Exxon Mobil (Exxon). We will compare SPC’s financial ratios, stock fundamentals and capital structure with its peers, so as to evaluate SPC’s business efficiency and the value-creation for investors vis-à-vis other oil companies.
FINANCIAL RATIOS ANALYSIS
|Profitability Analysis | | |SPC |Cosmo |Shell |Exxon | |Return on Assets (%) |14.41 |2.50 |16.30 |17.85 | |Earnings per share (EPS) |0.69 |0.47 |4.47 |7.28 |
As a relatively small player in the oil industry and having the smallest market capitalization (refer to appendix 1), SPC is able to achieve comparable high net profit margin of 5.8%, rivaling even huge player Shell – and this is due to the high net profit margin that is derived from its E&P (36%) business. But the net profit margin of sales of oil products is very low (at only 6%), indicating there is a long way to go before SPC can earn the sterling results Exxon Mobil has (11.3% profit margin). SPC’s high ROA and ROE ratios reflect management’s efficiency in utilizing assets and creating value for investors.
Oil companies are notorious for reporting non cash line items in the income statement. By stripping away all the non-cash entities, we can get a truer number because cash flow cannot be manipulated as easily as net income can. SPC’s cash EPS of $0.50 is an indication that it is in good financial health. However, Cosmo appears to be having cash flow problems as shown by a negative Cash EPS.
|Short term Liquidity | | |SPC |Cosmo |Shell |Exxon | |Quick ratio |0.78 |0.54 |1.64 |1.22 | |NWC to total Assets (%) | | |SPC |Cosmo |Shell |Exxon |
Times Interest Earned ratio measures a company’s ability to service its debt in the long term, measured by earnings divided by annual interest payments. A higher ratio means that the company can meet interest obligations more easily, since earnings are many times more. SPC’s TIE ratio, at 18.5, is lower than both Shell and Exxon Mobil, which indicates that default risk is relatively higher. Failing to meet debt obligations may force a company into insolvency.
|Financial Leverage | | |SPC |Cosmo |Shell |Exxon |
The debt/equity ratio is important in determining the debt level of the company. A high debt level may lead to poor credit ratings, weakening the company’s ability to finance its capital expenditures. We note that SPC has debt ratio of 0.50, higher than Exxon and Shell, as it requires considerable external financing for its expansion projects.
|Market Value | | |SPC |Cosmo |Shell |Exxon | |Price to Book ratio (P/B) | | |SPC |Cosmo |Shell |Exxon | |Inventory turnover |11.04 |8.25 |9.58 |21.36 |
SPC’s asset use, on the whole, is rather efficient and comparable to its peers. Despite being a small company, it is able to more nimbly utilize its assets, and achieve fairly impressive efficiency. Going forward, SPC needs to focus on increasing inventory turnover, which could come by taking on contracts with shorter accounts receivables period, so that it can more fully utilize the assets.
Analysis of SPC’s beta
It can be observed that SPC generally has a beta higher than that of the market. This means SPC has high systematic risk and its stock price is more volatile in nature. This can be explained by a causational relationship, based on the fact that earnings of SPC are highly dependent on the state of the economy. Logically, the expansion and growth of the economy would bring with it increases in consumption of energy for heating, electrical or transportation purposes, leading to increase in demand for refined oil products.
Following that, the increase in demand would drive prices for refined oil products higher, leading to higher refining margins. And the converse is true, an economic slowdown would entail a lower demand for energy leading to lower earnings. SPC is thus highly susceptible to unanticipated changes in systematic risk-related forces such as changes in costs and oil prices, which affects the value of SPC’s inventory and prices of its products. Thus, SPC’s earnings outlook depends heavily on the market demand for refined oil products, which is in turn dependent on market conditions.
Comparison to peers’ beta
| | | |SPC |Cosmo |Shell |Exxon | |Standard Deviation (%) |13.03 |10.26 |7.04 |5.40 | |Average yearly Market return |12.974% |11.944% |11.187% |8.070% | |Average yearly risk-free rate |1.578% |0.135% |2.663% |3.781% | |Average Market risk premium |11.396% |11.808% |8.524% |4.289% | |Current risk-free rate |0.65% |0.45% |2.98% |0.37% | |Cost of Equity |18.19% |15.06% |7.25% |3.01% |
The cost of equity is the return that equity investors require on their investment in the firm. The specific cost of equity could be viewed as an expression of the riskiness of the specific industry. A high cost of equity would naturally indicate a higher risk company, of which investors would expect a higher return in compensation for the higher risk taken.
If we compare Cosmo with SPC, SPC has a higher risk, based on its higher beta, because both companies have similar market risk premium and current risk-free rate. Their difference in cost of equity can be similarly explained by the logic that explained the difference between market betas of the two companies.
As for Shell and Exxon, the value that they create from their E&P activities has made them less vulnerable towards market volatility, thus investors consider them to be less risky investments. Exxon, a US-based company, has a lower cost of equity compared to Shell, a Netherlands-based company, due to the extremely low risk-free rate in the US currently. Due to the credit crisis, the current risk-free rate in the US is only an astonishing 10% of the historical risk-free rate, inevitably lowering investors required return on the stock.
COST OF DEBT
|Cost of Debt |SPC |Cosmo |Shell |Exxon | |Sales revenue: |6,090.26 |35,395.45 |358,600 |3,451.78 | |Gross Margin : |8.52 |6.64 |31.65 |7.07 | |Year of Establishment | | |SPC |Cosmo |Shell |Exxon | |Dividend per share in USD (5 yr average) | | |2005 |2006 |2007 | |Dividends (cents/share) |32 |35 |60 | |Dividend yield |6.72 |8.03 |7.93 |
3Q08 Income statement
|Income Statement ('000) S$ |3Q08 |3Q07 |% | |Revenue |3,306,268 |2,260,976 |46.23 | |CGS |(3,237,823) |(2,115,294) |53.07 | |Gross profit |68,445 |145,682 |(53.02) | |Gross profit margin |2.07% |6.44% |(67.87) | |Other income |4,055 |5,928 |(31.60) | |Finance Income |1,078 |2,833 |(61.95) | |Operation expense |(20,201) |(21,255) |(4.96) | |Selling & Marketing |(2,120) |(1,480) |43.24 | |General Admin |(25,458) |(20,587) |23.66 | |Finance |(13,694) |(5,007) |173.50 | |Share of results of associates |0 |1,011 |(100.00) | |Share of results of Joint Ventures |2,785 |3,450 |(19.28) | |Profit before income tax |14,890 |110,575 |(86.53) | |Income tax expense |(14,383) |(12,460) |15.43 | |Net profit |507 |98,115 |(99.48) | |EPS (cents) |0.12 |19.04 |(99.37) | |NAV ($) |3.43 |3.49 |(1.72) |
3Q08 Downstream Operating profits
|Downstream ('000) |3Q08 |2007 | |Turnover | 3,218,800.00 |8,621,585 | |Operating Profit | (18,900.00) |523,165 | |Operating Margin |NA |6.07% |
Financial ratios at a glance
| |SPC |Cosmo |Shell |Exxon | |Quick Ratio: |0.78 |0.54 |1.64 |1.22 | |Debt/Equity |0.50 |1.20 |0.00 |0.10 | |Total Asset Turnover |2.03 |2.17 |2.84 |1.49 | |NWC turnover |21.6 |59.5 |5.8 |13 | |ROA |14.41 |2.5 |16.3 |17.85 | |Market Value | | | | | |Price to book ratio |1.43 | |Cost of Debt |Thousands |Average interest rate |Weightage |WA interest rate | |Due to subsidiaries |11,570 |3.92% |1.36% |0.05346% | |Weighted Average Interest Rate | | | |5.33% |
|Appendix 8 | |Taken from: http://www.exxonmobil.com/Corporate/investor_bondholder_faq.aspx | |EXXON MOBIL |31-Dec-07 | |Cost of Debt |Interest rate | |Aaa corporate bonds rated by Moody'S |5.51% | |Aaa corporate bonds rated by Standard & Poor's |5.54% | |Average Interest rate |5.53% |
|Taken from annual Report of Royal Dutch Shell | |ROYAL DUTCH SHELL |31-Dec-07 | |Cost of Debt |Million |Average interest rate |Weight-age |WA interest rate | |Variable rate dollar debt |416 |5.10% |7.45% |0.38008% | |Variable rate European debt |1737 |5.30% |31.12% |1.64925% | |Other variable rate debt |1306 |8.30% |23.40% |1.94192% | |Weighted average interest rate | | | |6.24% |
Taken from Cosmo Oil's annual report |COSMO OIL CO.LTD |31-Mar-08 | |Cost of Debt |Millions of Yen |Average interest |Weight-age |WA interest rate | | | |rate | | | |Loans from banks, insurance companies and other financial institutions,|321,284 |2.34% |63.80% |1.48966% | |secured, with interest at 0.55%-4.12% | | | | | | | | | | | |3.15% Unsecured straight yen bonds due in 2007 |- |3.15% |- | | |1.60% Unsecured straight yen bonds due in 2008 |2,500 |1.60% |0.50% |0.00794% | |Weighted average interest rate | | | |2.51% |
-----------------------  Investopedia (2008) The Industry Handbook: The Oil Services Industry. Available on the World Wide Web: http://www.investopedia.com/features/industryhandbook/oil_services.asp  The American Institute of Certified Public Accountants (2008) Unsystematic Risk and Valuation (Part I) Available on the World Wide Web: http://www.aicpa.org/pubs/cpaltr/nov2000/supps/audit4.htm  SPC Limited Unaudited Results for the Third Quarter and Nine Months Ended 30 September 2008. (Appendix 4)  Dow Jones International News (2008) Singapore Petroleum 3Q Net Pft S$619,000 Vs S$98.1M. Available on the World Wide Web, http://global.factiva.com.libproxy.smu.edu.sg
 SPC Limited Unaudited Results for the Third Quarter and Nine Months Ended 30 September 2008. (Appendix 4)  Dow Jones International News (2008) Singapore Petroleum 3Q Net Pft S$619,000 Vs S$98.1M. Available on the World Wide Web, http://global.factiva.com.libproxy.smu.edu.sg  Platts Oilgram News (2008) CEO of Singapore refiner SPC defends oil hedging strategy as minimizing risks. Available on the World Wide Web, http://global.factiva.com.libproxy.smu.edu.sg
Prepared for: Professor Dong Hong
SPC’s financial at a glance