MARC has affirmed its AA- and AA-ID(cg) ratings on Scomi Group Bhd’s (Scomi) RM500 million Medium Term Notes Programme (MTN) and KMCOB Capital Berhad’s (KMCOB Capital) RM630.0 million Murabahah Medium Term Notes (MMTN) facility, respectively. At the same time, MARC has revised the outlook on both ratings to negative from stable.

Scomi is primarily involved in the provision of oil and gas support services for the global oil and gas industry. It operates in four segments: oilfield services, energy and logistics engineering, energy logistics and production enhancement. KMCOB Capital is an indirect wholly-owned subsidiary of Scomi Oilfield Limited (SOL), the investment holding company of Scomi’s oilfield services business.

The outlook revision on both ratings reflect Scomi’s and KMCOB Capital’s exposure to the impact of uncertain oil and gas prices on the demand for oilfield services over the short-to-intermediate term. Low oil prices have prompted cutbacks in global oil exploration and development spending and MARC believes that profitability and cash flow generation of Scomi’s oilfield services business will remain under pressure if oil prices continue to be depressed. Scomi’s negative rating outlook also incorporates the challenges and risks associated with the RM1.85 billion (at spot rate of 1INR to RM0.7505) Mumbai Monorail Project (Mumbai project) recently secured by Scomi Engineering Berhad (SEB) and its consortium partner Larsen & Toubro Limited of India, in particular, the heavy working capital requirements and country risk exposure. SEB’s scope of works for the Mumbai project is valued at RM823.3 million.

The affirmed debt ratings, meanwhile, recognise the group’s above average business market position and good geographic diversity in its core business of oilfield services, partially offset by its exposure to continuing volatile oil and gas prices, its relatively high gearing level and the expectation of little debt reduction through 2009. The ratings of Scomi and KMCOB Capital are currently equalised in light of the significance of the group’s oilfield services business to the overall credit profile of both entities. The oilfield services business is currently core to the debt servicing capacity as it represents 73.9% of total revenue and approximately 73.2% of the group’s pre-tax profits (excluding extraordinary gains) for financial year ended December 31, 2007 (FY2007). At the same time, MARC acknowledges that Scomi’s consolidated business profile could alter over time as a result of its increasing exposure to the logistics engineering sector and its ambitions to develop its international presence in this sector, which could result in a divergence between the two ratings. Additionally, the increased issuance of debt at the operating subsidiary level will lead to structural subordination at Scomi’s level. MARC will continue to monitor the structural subordination at the holding company level, and the ensuing pressure on Scomi’s rating.

In the first nine months of 2008, Scomi’s pre-tax profit fell 56.1% to RM115.2 million, although revenue showed a marginal increase of 5.2%. The results reflect margin erosion as a result of higher operating costs as well as the effect of strengthening US$ against the ringgit. It reported a negative cash flows from operations (CFO) for the nine-month period of RM45.0 million compared to a surplus CFO of RM67.0 million for FY2007 on account of the deterioration in profitability and working capital metrics.

Given the continuing slowdown on global demand in the core markets of Scomi’s oilfield services and energy and logistics engineering divisions, MARC expects the group’s operating performance to remain under pressure and possibly weaken should market conditions deteriorate further. Despite its large order book of US$422.0 million with an average run-up to FY2010, Scomi’s oilfield business is noticeably experiencing somewhat slow contract replenishments in FY2008. Revenue contributions from monorail and offshore marine logistics businesses, nonetheless, are expected to temper the pressure on revenue and earnings somewhat. Scomi has acknowledged the need for immediate cost reduction and is in the midst of downsizing and realigning its global operations in order to preserve its cash flow.

Debt financing for the Mumbai project, estimated to be around RM250.0 million, could potentially raise the group’s consolidated pro-forma debt-to-equity (DE) ratio (net of available cash and cash equivalents) to 1.53 times (x) as of 3QFY2008 if fully drawn down, against the MTN’s maximum covenanted DE level of 1.25x. MARC notes that Scomi is in the midst of seeking an exclusion of the Mumbai project debt and contract proceeds from covenant calculations and concurrently seeking to bolster its equity base through a rights issue. MARC believes that the increased structural subordination that would result from the planned issuance of debt at project holding company level can be tolerated within the current rating, given anticipated incremental earnings and cash flow generation and in the context of its equity raising plans.

Ratings stability will be conditioned on progress at both entities with respect to cost-containment initiatives as well as maintenance of adequate liquidity and capital resources for the rating level. Aside from weak global economic conditions, MARC believes that Scomi and KMCOB Capital could face another obstacle over the intermediate term should the recently announced US Department of State sanctions on Scomi’s CEO and major shareholder prove punitive to the competitive standing of the group’s oilfield services business in the US market. MARC will continue to monitor developments for rating implications as further clarity emerges in relation to the impact of the sanctions.

Contacts:
Hafizan Haron 03-2090 2238/ hafizan@marc.com.my;
Nadia Edmaz Abdul Hadi, 03-2090 2262/ nadia@marc.com.my.