Hello all! Today I will be doing a deeper analysis of GSS Energy. I am personally vested in this company hence, I would advise readers to exercise their own discretion when reading this post. Recently, GSS’s stock price have been going on a rollercoaster ride and many people including myself were thinking of cutting loss. But I held on because the prospects of the company are bright and the business fundamentals are sound. In the coming paragraphs I will bring you through GSS’s business and the outlook.
GSS Energy mainly operates in two business segments. 1) The precision engineering business and 2) the Oil and Gas segment. To let you understand a fuller picture I did a timeline of GSS transformation from 2013.
If you realised I never really talked about their PE business in the timeline above because during the period of 2013 to 2017, GSS took a huge plunge by venturing into the O&G sector which caused the main bulk of the movement in share prices. But since you got a fuller picture of what happened within this critical time span for the company, I will now analyse the respective business segments and their prospects.
1) Precision Engineering
GSS’s core business has always been precision engineering. In fact, they were a pure play PE firm before the new management decided to bring them into the O&G sector. Many people don’t realise that GSS Energy have a functional and profitable PE business. Come on the company’s name itself is misleading enough haha! So let’s take a look at how the PE business have done so far since 2014.
Both revenue and gross profit have been growing. That’s a good sign. Also, in 2017 they are shifting to a larger facility in China which will allow them to accept larger and more sophisticated orders as they capitalise on the chance to improve the new facility.
And for 1Q 2017, their PE business continued to grow at about 28% Q over Q.
That is kinda impressive. With so many competitors in the PE industry, it is sometimes hard to grow one’s business. However GSS PE business have been able to consistently grow their PE’s business revenue and gross profit for the past 3 years. This shows that the management are able to position the company’s services such that it attracts larger sales order from existing customers or obtain new customers to the company and at the same time reduce cost of production.
The thriving semiconductor industry in 2017 have become a favourable tailwind to GSS’s PE business. With a strong record of building up the PE business, and demand for electronics set to grow this year, this could be a record year for the PE business for GSS. In fact, the CEO have also considered plans to further grow the PE business through strategic acquisitions or collaboration, spinning off the PE business have also been considered by the CEO. That shows the confidence he have in the PE business.
2) Oil and Gas exploration
I think this is the main segment that is important to many investors. Since this business is new to GSS and there have been a case of their failure in this new business segment. The CEO’s concept in the O&G is not ordinary. He wants to ensure that there are certainty of oil in the ground and that it must be low cost so that they will not be badly affected by changing oil prices.
CEO Sydney’s way to achieve those objectives was to acquire old abandoned wells in Indonesia and drill them. The rationale for that is simple. Back in the old days, the colonialists have created many oil wells for their own needs. But in WW2, the colonialists destroy these oil wells so that the Japanese could not get access to these resources. So by acquiring these old oil wells, the cost of production of drilling for oil in that area becomes low. (About US $12 per barrel estimated)
Of course, not every old oil well contains oil reserves. Extensive studies have been done by GSS before committing to any sites. The current one that they are working on the Trembul Operation Area is in the same basin as the one Exxon Mobil use to draw oil, so certainty of obtaining oil seems to be quite high. And if the Trembul Operation is a success, the CEO have in mind to expand around the area in order to grow their O&G business to be a full fledge player in the industry.
Also, the type of agreement that GSS signed with PT Pertamina, Indonesia national oil company is different from the one they signed in the 2014 debacle. For this arrangement, money earned in the sale of oil is first used to pay off the cost of production of the oil before profit sharing is done. And since, the oil is bought by the government there are some forms of certainty in the buyer.
Yup the risks of not obtaining oil, execution risk and low oil prices are definitely there. But in my opinion, these scheme of arrangement with Pertamina puts GSS in a better position to reap profits from the venture. Unless oil price falls below US$20 per barrel which is rather unlikely, this remains profitable for GSS. Also, as a show of confidence, CEO have been buying shares in Jan 2017.
GSS balance sheet looks fine. I am more concern about debt since O&G companies around the world have been going bust because of debt issues.
Debt free company! And the group have a rather strong cash reserves of about $11 million.
Cash flow is improving. Free cash flow have been rising ever since 2014. That is definitely a good sign. Haha credits to Investingnote for doing the calculations! 🙂
The CEO holds 17.99% stake in the company and a non-independent, non-executive director Glenn Fung holds a 13.44% stake in the company.
That’s a combine 31.43% stake in the company from 2 members of the board in GSS. The management definitely have their interests aligned with the shareholders. Furthermore, the CEO have been buying up shares in 2017 as well.
I feel GSS have more legs to run. Backed by a profitable PE business and with the oil business coming online in 2017, this could be a good year to watch for GSS. I think some of us are concern because FY 2016’s results are backed mainly by a once off income gain by the government.
If you realise without the once off income, they would only have about $3 million in profit for FY 2016. That translate to about PE 28x at current price. To see if the current price is considered undervalued after factoring some future catalysts, I shall try to do a conservative estimation based off some assumptions.
- No growth in PE business
- Company manage to retrieve oil from the ground
- Price of oil remains in USD$40 to USD$50 per barrel
Assuming there is no growth in the PE business, we are looking at a revenue of $70 million and an EPS of SGD 0.6 cents.
Now according to a QPR by GSS, there is said to be 24 million stock tank barrel of oil reserves in the Trembul area up to 800m deep. GSS subsidiary PT SGT a 49:51 JV is entitled to about 23% of the oil reserves there. So GSS is entitled to 49% of the 23% of total oil there are.
GSS’s contract with Pertamina is for 15 years, that would entitle GSS to have
49% of the 23% of 24 million barrel of oil = 2.70 million barrel of oil and after 3 years GSS’s stake will increase to 89% of the 23%.
Assuming a more conservative figure — GSS are entitled to only 2.16 million barrel of oil
So 1 year = 144 000 barrels of oil
Assuming GSS cost price per barrel is USD $20 (actual estimated is USD $12) and price of oil ranges from USD$40-50 (Let’s take USD $40 to calculate)
Net profit for GSS oil business per year (first 3 years) = USD 2.88 million = SGD 3.75 million (USD/SGD of 1.3) = EPS of SGD 0.755 cents
Total EPS when O&G comes online = 0.755 + 0.6 = 1.355 cents
Which translate to a PE ratio of 13 at share price of $0.175 (the price which CEO last bought his shares from the open market). Also note that my calculation is only valid for the first 3 years as after that GSS’s stake will increase to 89% as per the agreement signed.
If we were to consider oil profits from the 3rd year onwards**:
89% of 23% of oil reserves = 4.97 million barrels a year (from 3rd year onwards)
To be conservative let’s take around 4.5 million barrels.
Net profit for GSS’s oil business per year (from 3rd year onwards) = USD $90 million = SGD 117 million (USD/SGD =1.3x) = EPS of SGD 23.5 cents
Still assuming no growth in PE business from 3rd year onwards, total EPS = 23.5 + 0.6 = 24.1 cents.
Which translate to a PE of 0.7 at price of $0.175.
This is could be why CEO’s Sydney emphasize that GSS is undervalued.
The above is taking into consideration that there is no growth in the PE business and that oil prices ranges from USD$40 to USD$50 per barrel.
**However, its good to note that my type of calculating is not the most accurate as company will not be able to drill the exact amount every year. Hence, I hope my calculation help to shed light on how lucrative the potential of the oil business can be to GSS which is why in my opinion, many investors are waiting to see if the oil business will become successful.
one should monitor FY2017 closely to see the rate of change of pure earnings Q over Q. Supported by positive tailwinds from the semiconductor boom and with oil prices stabilising out, it is definitely a growth company at an inflection point. FY 2017 result may not be higher than FY2016 but one should always look at the real growth rate of earnings to determine if there is growth potential in the company. With that, I shall end my analysis, rmb to DYODD!