More on Sime Darby's RM1 billion loss in Qatar

To those unfamiliar with the Sime Darby Berhad project in Qatar, here is some background. This is what The Edge wrote on March 8, 2010:

Big Money: Keeping an eye on Sime’s growing list of cost overruns

Tags: Sime Darby Bhd

Written by Jenny Ng
Monday, 08 March 2010 00:00

The saying that there is no smoke without fire rings true yet again. This time it relates to the year-old speculation of losses incurred at Sime Darby Bhd’s oil and gas (O&G) projects in Qatar.

Sime Darby provided for RM210 million in cost overruns on its RM2.1 billion Maersk Oil Qatar (MOQ) project during its second quarter ended Dec 31, 2009. Sime Darby’s O&G sub-segment recorded losses of RM201 million in 1HFY2010, which led to RM110 million losses for the energy and utilities division.

The MOQ project had been dogged by rumours of cost overruns and losses — from as little as RM120 million to as high as RM800 million — in 2008 and 2009, all of which were denied by Sime Darby.

Two weeks ago, this publication highlighted the possibility of a provision of over RM100 million on Sime Darby’s other Qatar project — the RM1 billion Qatar Petroleum project in the Bull Hanine and Maydan Mahzan fields.

It turned out that the provisions were for MOQ to the tune of RM210 million. Both projects were awarded to then-listed Sime Engineering Services Bhd in 2006 and 2007.

When contacted, Sime Darby says the cost overruns were incurred on transport and installation, and hookup and commissioning works. These costs have been booked in and the project is expected to be handed over soon, it adds.

It is not clear if the overruns were the result of under-budgeting, an unexpected increase in raw material costs, or both, or some other reason.

In FY2009, Sime Darby had provided for the Qatar Petroleum project which resulted in losses of RM80 million for the O&G sub-segment. The project was completed and handed over last year.

The MOQ project is now 96% completed. In an analyst briefing, Sime Darby gave the assurance that all cost overruns had been provided for, and confirmed this in its response to
The Edge.

“Yes, at this point Sime Darby does not foresee any further cost overruns for both the Qatar Petroleum project and the Maersk Oil Qatar project. As stated earlier, the Qatar Petroleum project has already been handed over and is fully provided for,” says the company.

Besides a change in leadership at its energy and utilities division, following the resignation of Datuk Mohamad Shukri Baharom who has been replaced by Hisham Hamdan, Sime Darby says it is also taking steps to prevent a repeat of the cost overruns. Hisham was previously the executive vice-president for group strategy and business development.

“We are in the midst of reviewing and reevaluating the systems and processes in the division. Naturally this will involve tightening controls and ensuring the highest standards of project management and monitoring. The review will take more time. In the meantime, we continue to position ourselves to bid for more contracts and projects, and we are confident that the division will become an integral part of the group’s overall growth strategy,” it says.

Be that as it may, why weren’t the controls and high standards already in place, especially after the Synergy Drive mega merger involving eight listed companies (including Sime Engineering), whose ultimate goal is to grow shareholder value?

Some may consider the amount of RM210 million to be immaterial to a company with a market capitalisation of more than RM50 billion and makes an annual profit of over RM2 billion. Besides, the energy and utilities division is among the smaller of Sime Darby’s five core businesses in terms of revenue and income. Still, it is good money which could have been put to better use. Incidents like cost overruns indicate incompetence and inefficiency, which only support the argument for Sime Darby to overhaul its diversified and sprawling operations, including the listing of its plantation unit and selling the auto business.

Given the energy and utilities’ smallish contribution to Sime Darby’s bottom line, investors may find it easier to forgive the losses (the RM210 million provision works out to 3.5 sen per share) as they are overshadowed by the group’s combined earnings. This argument supports the case for keeping Sime Darby’s various businesses intact.

If the Synergy Drive merger had not taken place, the impact would have been more visible — possibly on the share price of Sime Engineering, for instance. Then again, cost overruns are not totally alien to Sime Engineering. Since its listing in August 2003, it fell into the red in FY2004 and FY2005 due to provisions for cost overruns.

Sime Engineering was the lead partner with a 35.7% stake in the Malaysia-China Hydro Joint Venture, which was constructing the main civil works for the Bakun Hydroelectric Project. The contract was worth RM1.8 billion. In FY2004, Sime Engineering made a provision for RM77.1 million for foreseeable contract losses arising from changes in the cost structure of the project.
In FY2005, it made an additional provision of RM55 million on the same project as it experienced delays, bringing the total provisions on the project to RM130 million.

Although it has to be said that the recent provisions were for the O&G sub-segment and the earlier provisions were from the construction business, one can’t help but wonder whether Sime Engineering has learnt from past experience.

To be fair, cost overruns and delays are risks prevalent in engineering and construction works, and 10% cost overrun is sometimes considered the norm depending on the nature of the job and reasons for the cost increase. The good news is negotiations with the client could lead to write-backs. However, these may take time.

With a new guy helming Sime’s energy and utilities division, shareholders and investors will be keen to see if he can bring about positive changes to the O&G business and entire division as well. With a growing list of cost overruns, investors will certainly be watching closely.

You can read the article here.