Interactive Investor

Stockwatch: a bombed-out mid-cap share for your watchlist

14th October 2022 10:22

Edmond Jackson from interactive investor

This investment carries risk if you buy and risk if you don't. Analyst Edmond Jackson explains ahead of this firm's strategy update next month.

The chart for mid-cap company John Wood Group (LSE:WG.) continues downwards with no sign of forming a base, yet its directors have bought over £300,000 worth of shares since the August interim results. Is it time to buy, or should you wait for the chart to bottom out?  

Last January, I wrote positively on Wood at  around 250p given a context of rising oil prices – enabling management to update with a significant rise in the year-end order book “supporting our expectations for increased activity in 2022”.  

Margins had also improved, helped by cost efficiencies, and consensus forecasts were for a resumption of dividends near 13p a share.  

I noted, however, the update made no mention of a dividend, simply a commitment to review policy as operating markets recover. Net debt of around £1 billion equivalent weighed on pay-out potential, the 2021 interims having shown the net interest charge took 55% of operating profit.  

The balance sheet context was £3.8 billion equivalent net assets (translating from US dollar figures), albeit with intangibles constituting 117%.  

The stock had just leapt 25%, however, after this update also cited a full sale process for Wood’s “built environment” consulting side, equating to around 20% of group revenue.  

A November 2021 strategic review had aimed to unlock value from this business, with reports citing £2 billion could potentially be raised from such a sale, versus Wood’s then £1.7 billion market capitalisation.  

Any big cash injection would transform Wood’s balance sheet and radically improve the stock’s risk/reward profile. Given 4% of issued shares were loaned out to four hedge funds with short positions, their buying back would also help the stock. 

That at least, was the theory. 

Management guided for the sale to happen in the second quarter of 2022; completion took until September. Just under £1.5 billion equivalent net cash proceeds should now nearly have eliminated debt, given it rose near £1.6 billion equivalent by last June – the interest charge resulting in a modest interim loss. 

Force majeure of Ukraine war smashed assumptions 

Bigger events have distorted a re-rating case as industrial cyclical stocks were hit hard. 

Wood slumped to near 150p by early April, rallied back to over 250p by late May, but has now slid to 115p which capitalises the group at near £820 million.   

Disclosed short positions (i.e. those over 0.5% of issued shares) have however eased from 4.0% to 2.5% of its stock. Blackrock trimmed its short 0.2% below 1.7% on 30 June, although GLG Partners edged theirs up from 0.8% to 0.9% on 30 September. 

The short side has manifestly played out well.

So far back as charts are available, it is worth noting how Wood is now 25% below its 150p levels in 2004, as if the market is treating the company as a dinosaur – unable to adapt to serving alternative energy industries.

Yet at last August’s interims, management cited an increase in demand for consulting for de-carbonisation opportunities – both for new and existing clients.  

Reporting in US dollars, “energy transition” client wins were modest in overall context though at over $50 million. The company’s website promotes a “green” line: activities in carbon capture and hydrogen, “a clean and abundant energy vector to meet growing demand”; also biofuels, solar, wave, tidal and wind 

Little genuinely adverse in Wood’s news flow 

A 7 July update in respect of the first half-year cited the end-May order book up 18%, the projects side enjoying 30% like-for-like growth – led by engineering design. The backdrop was “strong market demand for our engineering solutions”. 

Mind, operating margins remain a lowly 1.6%, which likely compromises the price/earnings (PE) multiple – currently around 10x expected 2022 earnings, easing to 6x in 2023, assuming consensus for Wood to make near $130 million net profit this year, rising to near $150 million in 2023. 

Perhaps partly due to a “continuing operations” emphasis (with the built environment side being sold), the 23 August interims then cited the order book up barely 5% at $6.4 billion and flat revenue of $2.6 billion. Operating profit before exceptional items fell 9%, and after one-offs was flat at $30 million.  

But despite a possible tell-tale sign of slowdown, the new CEO from July said: 

“I have been really encouraged to see the improving operational momentum across our business, including some great client wins. The strong order book gives me confidence for the future but there is a lot more to do on cash generation and this is our top priority.” 

The financial summary table actually shows a decent record on free cash flow until 2021 when it slumped to negative. Operational cash flow was decimated and $73.5 million also went out in tax. 

John Wood Group - financial summary
Year end 31 Dec2015201620172018201920202021
Turnover - $ million5,0014,1215,39410,0149,8907,5646,426
Operating margin - %3.22.20.51.73.1-0.40.5
Operating profit - $m15989.427.9165303-32.932.3
Net profit - $m79.027.8-32.4-8.972.0-229-139
Return on capital - %5.03.00.32.14.10.5-0.1
Reported EPS - cents17.37.3-7.4-1.310.5-34.1-20.6
Normalised EPS - cents67.551.338.728.722.2-0.31.1
Operating cash flow/share - cents12349.534.280.996.445.1-8.8
Capital expenditure/share - cents21.822.718.013.821.313.117.0
Free cash flow/share - cents10126.816.267.175.031.9-25.8
Ordinary dividend/share - cents30.310.834.034.50.00.00.0
Covered by earnings - x0.60.7-0.20.00.00.00.0
Cash - $m8515801,2571,3531,857585491
Net debt - $m3203491,6411,5592,0521,5681,855
Net assets/share - cents633576732674645606590
Source: historic Company REFS and company accounts

The 2022 interim cash flow statement then cites cash absorbed by operations up from $79 million to $117 million, pre-tax, a $55 million decrease in payables being a key element of change within working capital. 

New CEO to launch updated strategy in November 

This strategy update could add something new to boost sentiment. 

Ken Gilmartin was initially appointed chief operating officer in August 2021 after 15 years with Jacobs Engineering Group, becoming CEO this last July. 

Wood’s chairman says Gilmartin has already “brought clarity, structure and focus...the board believes he is a great fit for Wood...this new strategy will focus on core strengths, return us to growth and deliver sustainable free cash flow.”  

Cluster buying by directors since August results

Meanwhile, a total £315,355 has recently been spent by five directors accumulating equity. 

Gilmartin snapped up £234,600 worth at 138p after the strategy and development director bought £45,250 at 129p. 

Three non-executive directors have also spent in a smaller way as the stock fell: one bought £21,777 worth at 145p, another £11,365 at 134p, and a third £2,541 at 125p.  

While all were “initial purchases” and it is good practice for directors to own equity, in total and respecting the size of the executive purchases, they convey genuine belief in value. 

There is a vague read-across to peer company Petrofac Ltd (LSE:PFC) where on 4 October, five non-executive directors each bought £5,000 worth of shares at 107p and the chairman bought £20,000 worth.   

Much depends on whether a global recession happens 

Both Wood and Petrofac have de-rated since last springtime, as war in Ukraine exacerbated inflationary pressures – hence central banks belatedly taking tough action via interest rates. 

The outcome – whether a short recession followed by monetary easing, or chronic stagflation and/or a financial crisis – will likely be the chief determinant of whether Wood rebounds or continues to reward the two main short-sellers.  

New strategy can only have a modest effect in a fundamentally low-margin industry, hence demand must not slide. 

I have been premature on calling this stock bullishly, although force majeure of the Ukraine situation compromised the “buy” case. 

But everything has its price, and I would respect the director purchases in a context where the company has just radically improved its financial risk profile.  

Yesterday’s sharp rally in the US shows the risk also with ignoring stocks when they are sold off, hence I flag Wood at least for watch lists, and a candidate to consider averaging into. Buy. 

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

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