KMCOB Capital Bhd - 2010 Credit Commentary Report

MARC has removed KMCOB Capital Berhad’s (KMCOB) RM630 million Murabahah Medium Term Notes (MTNs) from MARCWatch Developing.  At the same time, MARC has affirmed its AA-ID(CG) debt rating on KMCOB with a Stable outlook following the recent completion of Scomi Oilfield Limited’s (SOL) debt rationalisation exercise.

KMCOB Capital is a funding vehicle for SOL, and the MTNs are ultimately guaranteed by SOL, which in turn is 76.1%-owned by Scomi Group Bhd (Scomi). The debt rationalisation exercise which was completed on June 14, 2010 involves a three-year extension of maturity dates of tenure and repayment dates of each of the four series of the outstanding MTNs. In consideration for this, noteholders will receive higher profit rates and a put option to require KMCOB to repurchase all or part of the notes from 2014, subject to certain conditions being met. SOL will also undertake not to declare or pay any cash dividends without the prior consent of noteholders. MARC regards the debt rationalisation exercise as neither coercive nor distressed, absent the explicit threat of a missed payment had the exercise not proceeded, and in light of the generally noteholder-friendly debt restructuring terms. The agency believes that the restructured maturity dates will provide SOL with sufficient operating flexibility over the medium term while addressing the need to maintain credit measures supportive of its current rating level.

SOL is a significant player in the global drilling fluids and drilling waste management industry, with a market share of 6.6% and operations in 29 countries catering to a well-diversified client base of international oil majors. The group's earlier debt-funded expansion has increased its debt burden while consolidation among the global players and a decline in drilling activities in the Western hemisphere has exerted visible pressure on its earnings and ability to maintain cash flow debt service coverages consistent with the current rating level based on the original redemption schedule of the MTNs.

Based on SOL’s unaudited management accounts for the first quarter of the financial year ending December 31, 2010 (1QFY2010), the group’s operating profit margin increased to 8.2% (FY2009: 6.3%), driven by its cost saving measures. The group’s current outstanding order book has been maintained at approximately USD380 million (RM1.24 billion) as at March 2010, which should sustain earnings visibility in the next few quarters. At the same time, the performance of SOL and other oil and gas drilling service providers remains subject to uncertainties related to its current operating environment, in particular the ongoing consolidation in the sub-sector and the implications of BP’s Gulf of Mexico oil spill on possible tightening of deepwater drilling regulations.

SOL’s cash balances as at March 31, 2010 declined to USD28.1 million from USD46.3 million in December 31, 2009 due to higher working capital requirements. KMCOB has received a one-time waiver for its non-compliance with its Finance Service Reserve Account (FSRA) build-up schedule for its series A notes with respect to the RM150 million Series A notes redemption in December 2010 maturities under the original repayment schedule.

Under the revised redemption schedule, KMCOB will still redeem MTNs amounting to RM150 million in total in December 2010 but this will now comprise RM93 million of Series A notes and a total of RM57 million  of  notes  from Series B, C and D. The RM150 million redemption will  be  met from the internally
generated cash flow of SOL as well as proceeds from the disposal of Oiltools Africa Limited and other non-core operating subsidiaries to Scomi amounting to USD21 million which will be captured in the facility’s FSRA.

SOL’s cash flow projections indicate that the cash flow at SOL should adequately support KMCOB’s debt service obligations under the revised redemption schedule. The agreed mandatory redemption schedule has allowed KMCOB to extend the maturities of RM240 million, or 38% of its RM630 million outstanding MTNs. Under SOL’s base case cash flow projections, SOL is expected to maintain a minimum annual debt service cover ratio of at least 1.50 times, as measured by closing consolidated cash and equivalents plus consolidated total debt service obligations to consolidated total debt service obligations, with its extended debt maturity profile post-restructuring.

MARC will continue to monitor SOL’s operating performance and its cash flow to ensure they remain consistent with the agency’s expectations for KMCOB’s affirmed rating.