Interactive Investor

Stockwatch: are struggling oil services stocks set for sharp recovery?

They’ve had a hard time of late, but our stock-picker thinks both of these shares merit attention

29th June 2021 13:41

Edmond Jackson from interactive investor

They’ve had a hard time of late, but our stock-picker thinks both of these shares merit attention for those with appetite for risk.

Why are oil prices rising – up to over $75 a barrel from sub-$40 last November and above pre-pandemic levels - yet oilfield services stocks are falling?

Specifically, Petrofac Ltd (LSE:PFC), which at 109p and around £400 million market cap is back to market value early last November before vaccines set stocks roaring. John Wood Group (LSE:WG.), at 217p and £1.5 billion, down 40% from levels only last January, is another example.

Yes, both companies’ narratives continue to manifest accountability regarding the Unaoil scandal and, in Petrofac’s case, other bribery allegations involving past employees.

Last March, Petrofac fell from 133p to 95p after the Abu Dhabi national oil company suspended it from competing for new awards. Yet this appears a visible reprimand to show Abu Dhabi takes the issues seriously, “until further notice” hinting at change again in due course. 

It is looking like an anomaly how the market has (over) priced many stocks for recovery from the pandemic, yet remains very cautious towards oil services. This has got beyond the bribery issue.

In over 20 years of following this specialist engineering sector, I have found it quite often more sensitive to oil price changes than exploration and production stocks. Demand for services can lag oil prices as project managers wait to see if oil price changes are sustained.

The market in these stocks appears to be taking a very cautious view: how the airline industry remains constrained and globally it will be years before we genuinely emerge from the pandemic. 

Mixed figures imply a challenge to assert intrinsic value 

Recent years’ financial overviews for both companies do make projections dicey. Wood has shown good top line progress albeit erratic profits, irrespective of last year. Petrofac’s revenues have steadily declined and profit is all over the place.  

Yet the market’s caution is not shared by the consensus of brokers’ analysts which targets £185 million net profit this year and £235 million in 2022, implying sterling equivalent earnings per share (EPS) of 19p rising to 24.5p – for a price/earnings (PE) ratio of 11x easing to just 8.7x if these forecasts are realistic.  

Both companies are avoiding dividends until services demand is firmly re-established, but if consensus on Wood is fair – to pay out nearly 7p a share equivalent and 11p in 2022 – then the current stock price offers a chance to lock in a near 5% yield with earnings cover over 2x.  

That has a feeling of a trough, although is a big uplift compared with the more cautious view on Petrofac: to recover net profit to about $50 million in respect both of 2021 and 2022, implying EPS around 15 cents or 11p, hence a forward PE of 10x. No payout is expected until and in respect of 2022 year, paying out about half of earnings for a 5.7p equivalent, total dividend.  

Low single-digit operating margins may deter exacting investors from exposure to this industry though, until an up-cycle is manifest. By then however, you would have long-missed the chart trough.  

Petrofac - financial summary
Year ended 31 Dec

Turnover - $ million6,8447,8736,3955,8295,5304,081
Operating margin - %-
Operating profit - $m-252186104159220-148
Net profit - $m-3491.0-2964.073.0-180
Return on capital - %-
Reported EPS - cents-1030.3-8.518.621.3-53.4
Normalised EPS - c-62.984.312412859.5-4.2
Operating cash flow/share - c19719012414069.4-4.8
Capital expenditure/share - c49.748.134.428.429.417.8
Free cash flow/share - c14714289.711239.9-22.6
Dividend/share - c65.863.012.737.00.00.0
Earnings cover - x-1.60.0-
Cash - $m1,5591,1679677261,025684
Net debt - $m1,1011,2131,159361423429
Net assets/share - c356317268210183125


Source: histroric company REFS and company accounts

Wood’s narrative implies a firmer trajectory of the two  

The default forward indicator for such engineering services groups as Wood Group is their “backlog” i.e. order book, which is typically seen as the crux leading indicator. 

In a 24 June update for its first half year, Wood cited revenue down around 21% due to Covid’s impact; yet a $6.9 billion backlog is up 6% on December 2020. “Following a steady start in the first quarter, we have seen improving momentum in activity in the second…expect to deliver strong like-for-like margin improvement…order book up 6%...confidence of a return to growth in the second half.” 

It was somewhat incongruous how the stock continued to drift down, given fundamentals look to be passing a turning point. While consensus projections appear bullish, improving margins as well as sales can easily bump up profits at a substantive group like Wood.  

Wood Group - financial summary
Year end 31 Dec

Turnover - $ million5,0014,1215,39410,0149,8907,564
Operating margin - %
Operating profit - $m15989.427.9165303-32.9
Net profit - $m79.027.8-32.4-8.972.0-229
Return on capital - %
Reported EPS - cents17.37.3-7.4-1.310.5-34.1
Normalised EPS - c67.551.338.728.722.2-0.3
Operating cash flow/share - c12349.534.280.996.445.1
Capital expenditure/share - c21.822.718.013.821.313.1
Free cash flow/share - c10126.816.
ordinary dividend/share - c30.310.834.
Covered by earnings - x0.60.7-
Cash - $m8515801,2571,3531,857585
Net debt - $m3203491,6411,5592,0521,568
Net assets/share - c633576732674645606


Source: histroric company REFS and company accounts

Yesterday, the stock eased further despite a market update about resolution of historic bribery issues to obtain contracts within the Amec Foster Wheeler companies, acquired in 2017. A total £128 million equivalent will be paid over the next three years.

It was hardly as if this came as any surprise, and normally such clarification clears the air so investors can look forward. Instead, the price fell, as if in jaundice. 

Petrofac’s backlog appears relatively harder hit

Yesterday’s update in respect of its first-half year cited the backlog down 20% to $4 billion, due to the UAE suspension but also “as clients continue to defer awards in other markets”. Secured revenue for 2021 comprises $3 billion so far, relative to $5.5 billion achieved in 2019. 

More positively, Petrofac says it is on course for $250 million cost savings which ought to help margins in the medium term. 

New orders are likely to remain depressed this year on the engineering and construction side, with management saying: “The recovery in oil prices has yet to manifest itself in a significant expansion in capital spending by our clients.” This is sweetened with the claim of “an active bidding pipeline of $48 billion opportunities due for award in the next 18 months”.  

Cynics may say that is jam tomorrow. Petrofac’s long-term chart has been in persistent if jagged decline from £17 in March 2012. But even in a worse-case scenario of the Serious Fraud Office finding dirt on the CEO of nearly 20 years, who retired at the end of 2020, the group has broken managerially with its past and retains strong market positions. 

Petrofac is becoming quite a takeover candidate  

Once regulators finally clear the air, like they have just done for Wood, it could be opportune to offer a decent premium to market value before oil prices prompt recovery in demand for services. Its market value is currently less than a third of Wood’s, hence less of a financial hurdle and easier to integrate.

Enough weary shareholders might capitulate although the ex-CEO’s family does own nearly 19%. Toscafund, an enterprising hedge fund, owns 5%. This accords with a contrarian investment case, plus takeover potential. 

I am quite a stale bull on Petrofac having had a broadly positive view in recent years and suggesting it as a ‘buy’ last January similarly at 109p.

As of the end of 2020, net tangible assets per share were 54p equivalent but arguably a service business merits some extent of goodwill/intangibles recognition, where overall net asset value (NAV) was 127p a share. It is not a stretch to say the stock is broadly around book value; another plus for takeover at what looks a cyclical trough for revenue/profit. 

Realise also, two other hedge funds marginally raised their short positions a few days ago, implying they anticipate a swingeing SFO fine plus further revenue erosion.

The overall short position has however plunged from about 9% last April to 2.6% and Morrisons (MRW) had about 3.5% of its stock shorted before a bid approach. Wood is similarly on 3.5% with two funds increasing and two reducing their shorts. 

Higher-risk ‘buys’ yet potentially higher rewards 

A trough on charts will only become apparent in hindsight, but I think both stocks merit attention, according to your risk preference. Wood has at least had its situation cleared up by the SFO, yet there are also contrarian reasons to accumulate Petrofac. Buy. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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