Scomi Group Bhd - 2011

MARC lowered its issue rating on Scomi Group Bhd’s (Scomi) RM500 million Medium Term Notes (MTN) programme to A+ from AA-. The rating was removed from MARCWatch, where it was placed with negative implications on July 27, 2011. The outlook on the rating is negative. The downgrades affect RM200 million of outstanding MTNs.

The one-notch downgrade for Scomi’s issue rating balances its low operating cash flow relative to maturing debt obligations and tight liquidity against the recent improvement in the group’s core business operations. In MARC's view, the current liquidity metrics of Scomi reveal a degree of vulnerability to 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 the group 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 Scomi face increased risk of a non-coercive debt rescheduling in coming months as the upstreaming of cash flow from its core earnings generator, oilfield services, would be limited by the immediate debt servicing needs at indirect subsidiary KMCOB Capital Berhad (KMCOB).

Scomi turned around with a consolidated pre-tax profit of RM47.7 million for the six months ended June 30, 2011 (1HFY2011) on revenue of RM735.6 million and improved operating profit margin of 9.75%. The order book for its oilfield services division, which contributes the bulk of the group‘s revenue and profits, shows healthy replenishment following an uptick in drilling activity, particularly in Malaysia. The group paid down RM254 million of debt in FY2010, mainly through proceeds from disposal of assets. The group’s gearing ratio as at end-June 2011 was marginally higher at 1.10 times (x) compared to end-December 2010’s 1.09 times. Scomi continues to maintain compliance with financial covenants under the terms of its MTN issuance although MARC notes a decrease in covenant compliance headroom in 1HFY2011. The group posted significantly reduced operating cash flow and free cash flow deficits of RM0.4 million and RM8.9 million respectively. MARC opines that internal cash flow generation over the next two quarters would be insufficient to meet its forthcoming notes commitments of RM200 million due next year.

Scomi intends to unlock liquidity through asset disposals and/or corporate exercise(s) to reduce its debt leverage. MARC opines that there is a possibility that Scomi may also seek a waiver or deferment of its forthcoming sinking fund requirements in view of the short remaining time frame to build up the sinking fund by March 2012 to redeem the RM200 million outstanding notes due in September 2012.

MARC will likely lower Scomi’s rating further if it 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 Scomi negatively. Conversely, the outlook could be changed to stable if Scomi is able to secure additional liquidity resources to pay down debt in accordance with its existing debt maturity schedule.

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