KMCOB Capital Bhd - 2011

MARC lowered its issue rating on funding vehicle KMCOB Capital Berhad's (KMCOB) RM630 million Murabahah Medium Term Notes to A+ID(cg) from AA-ID(cg).  The rating was removed from MARCWatch, where it was placed with negative implications on July 27, 2011. MARC also lowered its issue rating on ultimate parent Scomi Group Bhd’s (Scomi) RM500 million Medium Term Notes Programme to A+ from AA-. The outlook on both ratings is negative. The downgrades affect RM480 million of outstanding Murabahah notes issued by KMCOB and RM200 million of outstanding MTNs issued by Scomi. Scomi Oiltools Bermuda Limited (Scomi Oiltools), the immediate parent company of KMCOB and 76.1%-owned operating subsidiary of Scomi, has guaranteed KMCOB’s obligations under the rated notes.

The one-notch downgrade for KMCOB’s issue rating balances its low operating cash flow relative to maturing debt obligations and tight liquidity against the recent improvement in SOL’s and Scomi Group’s core business operations. KMCOB's noteholders recently consented to a further deferment of outstanding payments into its Finance Service Reserve Account (FSRA) to December 14, 2011.

In MARC's view, the current liquidity metrics of SOL reveal a degree of vulnerability to execution risk and less favourable-than-expected operating performance that are better indicated by the revised rating and negative outlook. Although MARC believes that there is a possibility that SOL can improve its operating cash flows in the second half of 2011 on the back of improved market conditions, the rating agency believes that noteholders of KMCOB face increased risk of a non-coercive debt rescheduling in coming months.

SOL turned around with a pre-tax profit of USD12.5 million for the six months ended June 30, 2011 (1HFY2011) after two consecutive years of losses, on revenue of USD165 million and improved operating profit margin of 11.5%. Its order book also shows healthy replenishment with the uptick in drilling activity, particularly in Malaysia. KMCOB continues to maintain compliance with financial covenants under the terms of its MTN issuance although MARC notes a decrease in covenant compliance headroom in FY2010. Cash flow from operations (CFO) for FY2010 declined to USD33.5 million (FY2009: USD58.6 million) and as a means to conserve cash to meet its forthcoming debt commitments, there were no major  capital expenditures, resulting in free cash flow of USD58.6 million and USD30.6 million in FY2009 and FY2010 respectively. KMCOB pared down debts of RM150 million in FY2010 but gearing was marginally lowered to 1.38 times (x) (FY2009: 1.40x) as a result of losses incurred during the year which reduced shareholders’ funds to USD140.4 million from USD158.6 million the previous year. Gearing as at 1HFY2011 stood at 1.40x.

MARC will likely lower KMCOB’s rating further if SOL is unable to secure additional liquidity resources through asset disposals or other external sources and/or internally generated cash flow comfortably ahead of payment dates for forthcoming rated debt obligations. The downgrade would not necessarily be limited to one notch and the rating agency will likely view any further solicitations of covenant and sinking fund build-up payment waivers by KMCOB negatively. Conversely, the outlook could be changed to stable if SOL is able to secure additional liquidity resources to pay down debt in accordance with its existing debt maturity schedule.

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