The February 2018 MCS is interesting in that it's based on an oil company named Nortan, but focuses mostly on a shared service centre where a number of the company's administrative tasks are centralised, called the FOSSC. The purpose of this article is to analyse the financial statements of the Nortan Group. We are told that Nortan runs an enormous operation with over 200 subsidiaries, so we're dealing with consolidated financial statements. Nortan seems to have 100% ownership of these subsidiaries, as there is no sign of any non-controlling interests on the financial statements, which somewhat simplifies the task of understanding them.
The consolidated statement of profit or loss for 2017 shows that in spite of a health 18.3% increase in revenues compared to 2016, Nortan has still suffered a disappointing 35% decline in net profit. There are two main reasons for that drop in profitability: 1). cost of sales is rising at a higher rate than revenues and 2). the profit on the disposal of exploration and evaluation assets have declined significantly in 2017 compared to 2016. Cost of sales have risen by a massive 48.6% since 2016. It may well be that new oil is proving harder to extract, as all the low-hanging fruit has been picked over the previous decades. Companies are having to employ costlier methods such as fracking to extract harder-to-reach oil, which undoubtedly contributes to higher costs. The fact that innovative techniques such as fracking are still in their infancy, means that the technology is still expensive, meaning that depreciation expenses associated with this machinery would also be high, thus driving cost of sales higher. The second big impact on the net profit for 2017 is the fact that the profit on disposal of exploration and evaluation assets is only a third of what it was in 2016. If we were to assume the same profit on the disposal of exploration and evaluation assets in 2017 as for 2016 i.e. C$1,641.3 million, then there would have actually been a 43.7% increase in net profit for the year. So, the overall performance is not as bad as it first seems. However, it's concerning that cost of sales growth has far outstripped revenue growth. This may be temporary however, as revenues may have been depressed by a historically low oil price over the last two years. If oil prices return to the levels of 5 years ago, for example, then we would see a big positive turn in revenues.
Turning to the consolidated statement of financial position, and we see there have been no acquisitions over the last year. That looks set to change with the pre-seen mentioning that Borland Oil is being acquired by Nortan. The cash position has more than trebled in the last year and overall, Nortan looks to be bolstering its liquidity position (the current ratio has doubled from 0.8 in 2016 to 1.6 in 2017). I believe the company may be holding off on investment opportunities given the current climate of low oil prices. This would explain the rising cash position as well as the fact that exploration expenses (see the profit & loss statement) have dropped 28% in the last year. Nortan has also retained 61% of its net profit, again indicating that they are holding off on big CapEx projects for the time being at least. This is a company with many financing options should they need to make a big investment. The gearing ratio (long-term debt/equity) stands at a comfortable 15.5%, they have plenty of assets and subsidiaries to divest if they need to, and they have good cash reserves.
The segmental analysis provided in the pre-seen gives us some useful additional data. The big regional movers over the past year have been the Middle East and Asia. The Middle East region's revenues have fallen by 57.2%, while the Asian region's revenues increased by a massive 342.4%! One would suspect that Nortan has shifted its emphasis to Asia, but when we review the asset base for each region in 2017, they are more or less in line with 2016. It may well be that political turbulence in the Middle East in 2017 caused the big drop in revenues. It may also be that 2016 was just an exceptionally good year in the Middle East and that 2017 represents a return to the norm. In fact, that is more likely the case, as the asset turnover (revenues/assets) of 0.93 in the Middle East in 2016 was far in excess of the average of 0.38 for the company as a whole. It's the Asian region's turn to over-perform in 2017, as its asset turnover is 0.96 in 2017. However, it's also evident that much higher costs were incurred in Asia in 2017 to secure such high revenue growth. The operating profit margin for Asia in 2017 stands at just 20% compared to an average for the company of 29% across all regions.
In conclusion, Nortan looks well-placed to take advantage of a rebound in the oil price. They have a range of financing options to tap should they wish to make an acquisition or big CapEx investment. Having said that, they would do well to control their cost of sales figure, with Asia in particular looking to have incurred very high costs to achieve the revenue growth it did in 2017.
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