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.

Dana Gas 3Q 2018 Earnings: "Woof, Woof"

Earlier this year, I took a look at DG’s 1Q18 earnings and made some predictions for the full year.  A best case 4.5% ROE or worst case a break-even year.  As you’ll note, the best case falls well short of what would be an adequate return given the risk profile of DG.  

So how does AA’s prescient prediction look with a full three quarters of data?  

Frankly, not so good.                  

DG reported USD 41 million in net income for the first nine months of the year.  Pro-forming this for the full year, would result in roughly USD 55 million for the full year or an ROE of 1.9%.  

But to get a sense of the return from ongoing operations, we need to exclude two special items.  Those are USD 8 mm in 2Q18 sukuk restructuring expenses and a 1Q18 reversal of 13 million in previously accrued expenses.  If we exclude both amounts—a net of negative USD 5 million--, DG earned some USD 36 million over the first nine months of the year.  Pro-forming this over 12 months results in projected full year net income of USD 48 million or an ROE of 1.7%.  

Inadequate when one considers what would be a normal ROE for a stock investment.  

Dismal indeed when considers the higher ROE that that a risky stock like DG should deliver. 

To boot DG’s ROE remains well below its current roughly 4% cost of borrowing which is artificially depressed from the appropriate risk adjusted cost by the restructuring.  

Of course, there could be a miracle in 4Q18. 

The hoped for settlement with NIOC could materialize.  The US Government could graciously facilitate Iran's payment of the settlement proceeds to DG and, perhaps, as well give DG a license exempting its transactions from newly re-imposed US sanctions on Iran.  

At this point, it appears that the best value creation opportunity DG has is to repay its debt in full.  That will result in a net "benefit" of some 2.1% per annum to shareholders.  Dividends are another option - as it might be expected that shareholders could find other investments to return more than 1.9% a year.

To end on a rare (for AA) positive note,   all things are relative.   

DG may be a “mutt” investment, but AA suspects that investors in Gulf One Investment Bank Bahrain might find it quite attractive. 

Gulf1 has not reported a profit since FY 2013 and appears poised to continue that "run" in FY 2018.  Over the period FY 2014 through FY 2017 Gulf1 “lost” (that doesn’t mean “misplaced”) some 57% of its total equity:  from USD 133 million at FYE2013 to USD 57 million at FYE 2017.  

It’s hard to say how FY 2018 will turn out, though the loss this year for nine months is larger than for the comparable period last year.  But as is well known providing an opinion on fiscal year audited financials generally concentrates the minds of auditors more sharply than the  signing off on interim unaudited financials.  In 2017, the bulk of G1's USD 27 million loss was booked in 4Q.

On another somewhat positive note:  Gulf1 is equity funded so there are no lenders with significant exposure and thus in significant danger.

Brexit: Bishops Pray for Politicians' Integrity Amid Brexit Turmoil

"Father" Ethan Rushes to Join Prayers

According to The Guardian, Church of England bishops have said they are praying for “courage, integrity and clarity for our politicians” after a week of turmoil over Brexit.

According to the Bible, "With God all things are possible".

However, as you'll note, while the Bible speaks about "possibility", it is silent on "probability".  No doubt to cover situations like this.