KMCOB Capital Bhd - 2010

MARC has affirmed its AA-ID(CG) rating on KMCOB Capital Berhad's (KMCOB) RM630 million Murabahah Medium Term Notes and revised its rating outlook to negative from stable. KMCOB is ultimately held by Scomi Group Bhd (Scomi) through 76%-owned subsidiary Scomi Oilfield Limited (SOL). SOL has guaranteed the obligations of KMCOB under the rated facility. The rating action is concurrent with MARC's affirmation of Scomi's senior unsecured debt rating of AA- and revision of its outlook to negative from stable. MARC regards SOL as core to Scomi Group which is analysed on a consolidated basis given the concentration of strategic and financial decisions at the ultimate holding company. In 2009, SOL's oilfield services division revenue and segment results accounted for 67.8% and 63.3% of the respective consolidated totals at Scomi Group level.

KMCOB's rating is presently driven by and aligned to Scomi's rating, although improvements in the creditworthiness of SOL's own operations could positively influence the direction of KMCOB's rating. Nonetheless, MARC sees the likelihood of this to be limited over the foreseeable future, which results in KMCOB's rating outlook also being aligned to that of Scomi.

In the first nine months of 2010 (9M2010), SOL reported revenue of USD265.9 million. Although revenue was 8.1% down from 2009 on an annualised basis, SOL appears to have recovered from a pre-tax loss of USD1.7 million in fiscal 2009 with a pre-tax profit of USD8.4 million for 9M2010. It also registered an improved operating profit margin of 8.0%, up from 4.4% in 2009. The business prospects of SOL's drilling fluids and drilling waste management business remain dependent on the outlook for exploration and production (E&P) capital spending. Although the utilisation rate of drilling equipment has improved, rates remain under pressure and will continue to weigh on the performance of SOL's drilling waste management business. Offsetting this somewhat is the stable performance that is anticipated for SOL's drilling fluids business.

MARC believes that the cost-cutting measures implemented by SOL and lower reinvestment levels have helped to reduce the impact of lower levels of activity on its profit margins and conserve liquidity. The oilfield services division's outstanding order book increased to USD366 million as at June 2010 (June 2009: USD328 million) with major contract wins concentrated in the Asia Pacific region. MARC notes that SOL’s orderbook replenishment has improved in 2H2010, which could improve its earnings prospects in the coming quarters. Its declining presence in its Western Hemisphere markets and recent loss of exclusive distributorship for Derrick solids control equipment, except in Nigeria and Russia, could pose challenges to improving its financial performance unless compensated by meaningful earnings growth arising from the group’s strategy to refocus on Eastern Hemisphere markets.

In FY2009, SOL's cash flow from operations (CFO) increased to USD58.6 million on account of increased working capital requirements. SOL’s free cash flow improved to USD58.6 million, reflecting capital spending restraint. SOL’s days receivables have also improved to 100 days in 9M2010 compared to 112 days in FY2009. Cash balances as at September 30, 2010 increased to USD59.5 million from USD46.4 million in December 31, 2009, bolstered by proceeds from the disposal of its machine shop operations in Africa to Scomi.

SOL’s debt-to-equity ratio increased to 1.65 times as at September 30, 2010 (December 31, 2009: 1.45 times) with the drawdown of additional trade lines during the period to fund the redemption of approximately USD46.2 million of MTNs. The DE ratio should decrease to approximately 1.25 times upon repayment of MTN maturing in 2010.

SOL’s weaker-than-expected operating performance in recent quarters increases the likelihood that support will be required from Scomi to deleverage its balance sheet.

Major Rating Factors

Strengths

Challenges/Risks