Friday, 31 May 2019

Dana Gas: FYE 2018 and 1Q2019 Financial Performance - A Brighter Picture But Not by Much

A 5 Watt Bulb is Brighter than 2 Watts

Last December I made a bold prediction based on DG’s 3Q18 financials that the company would have a break-even year or at best case perhaps earn a 4.5% ROAE.  
DG’s 2018 financials  (but not its glossy annual report) have been released. 
Let’s take a look and see how prescient AA’s prediction was.  
Net income for 2018 is what might charitably be described as “disappointing”, a net loss of USD 186 million driven by impairment provisions of USD 250 million.  USD 187 million for the write-off of the Zora field and USD 59 million for certain Egyptian assets (or perhaps uncertain Egyptian assets).  
Pretty far off from AA’s less than less than "prescient" prediction a scant five months ago.  
In the MD&A section of the report DG’s Directors emphasize that the 2018 impairment provisions were “non-cash items” and that “On a like for like basis, excluding one off impairments, profit from core operations increased to USD 64 million (AED 234 million) as compared with USD 5 million (AED 18 million) in 2017".  
On that basis, DG earned an ROAE of some 2.35% using total shareholders’ equity as reported on the balance sheet.  If we adjust 2018 equity for the non-cash impairment that year (add it back) then ROAE is 2.27%. 
In the Directors’ “best” case, a dismal return.  
Certainly well below the risk-adjusted return DG should be earning given its business concentration in risky markets.  Equally well below the return it should be earning ignoring risk.  
However, the picture in 1Q19 is brighter, but only marginally in an absolute sense.  
Net income of USD 35 million, largely driven by a USD 10 million reduction in interest expense.   If this pattern continues, projected ROAE for 2019 is some 5.3% much better than 2018.  
But still subpar for the risk.  No longer pitch dark.  But a 5 watt bulb is cold comfort.  
There was other good news.  
Continued reasonably good collection of receivables from Kurdistan.  
A less favorable 70% collection rate in Egypt, including some receipts in Egyptian pounds.  A less than happy approximate USD 9 million increase in Egyptian receivables.  Both factors –accepting funny money (Egyptian) and increasing receivables --something to keep an eye on.  
DG also reported that it and Pearl had prevailed in their arbitration (LCIA) with MOL over the KRIG settlement. 
So is DG out of the woods?  
Not quite yet.  
While better than 2018, the projected ROAE is still not at a level that a company with this risk pattern should be earning.  
One quarter does not a turnaround make.   
More importantly the factor driving the turnaround is financial not operational.  The current interest charge is based on a non-market rate.  Once the company has to borrow at market rates again, this financing advantage will disappear.  And financing will be important if DG is to materially grow its business.  
With an approximate 5% ROAE, there will also be little opportunity to use financial leverage to increase shareholders returns materially.  And, if lenders demand more than the ROAE, leverage will actually diminish ROAE.
There's a real negative on the operational side: the write-off of Zora.  It was DG's one revenue stream from a creditworthy country. Admittedly small, but perhaps with a potential to grow.
There's also another cloud on the horizon.  
DG is looking at a roughly USD 400 million principal payment on the sukuk in October 2020 some 17 months from now.  
With USD 442 million in cash as of 1Q19, an almost certain USD 95.5 million dividend this year and one next year which is likely to be approved and paid prior to repayment date, there’s little margin for error. 
The sukuk lenders/investors did not or could not impose any real control on DG's payment of dividends.  They agreed that DG could pay dividends equal to 5.5% of paid-in- equity on the condition that after such payment, DG would have cash of at least USD 100 million.  And they did this knowing the repayment due in October next year was going to be a multiple of USD 100 million.  Roughly 4 times.
If DG is able to honor the repayment obligation in full, and that’s not certain, it could be left with little cash for its business.  
In such a case it’s hard to imagine investors and lenders rushing to support DG, but then they (lenders and investors) routinely demonstrate little common sense in their underwriting. 
So the future while brighter (5 watts instead of 2 watts) isn't bright enough to lift DG from the dog investment category.