One of our companies analyst’s tips is doing well, and shares in another in the same sector rocketed this week. Find out what he thinks about prospects.
Oil prices have hit two-month highs amid tight supply. US crude inventories are down by more than anticipated to their lowest levels since 2018, as reductions in refining activities have conflated with greater demand.
The US situation also mirrors that globally, as major oil & gas producers struggle to increase supply, while fuel demand keeps rising despite the pandemic’s latest wave of infection.
The International Energy Agency does expect prices to ease: the Brent Crude price, which averaged $79 a barrel in the fourth quarter of 2021, is forecast to average $75 during 2022 and $68 in 2023. Supply increases should keep companies busy and be positive for the oil services industry.
Higher oil & gas prices are boosting industry activity
On 13 January it was notable that John Wood Group (LSE:WG.) cited its year-end order book up “significantly” year-on-year, “supporting our expectations for increased activity in 2022”.
Margins also improved by around 0.5%, helped by cost efficiencies.
Before this full-year trading update, consensus for 2021 net profit had been $145 million rising to $191 million in 2023, equating to earnings per share (EPS) of around 22 cents (16p) and 29.5 cents (21.5p) respectively. With the stock currently around 240p, that equates to a forward price/earnings (PE) ratio of 15x, reducing to 8.5x.
- 34 value stock tips for 2022
- Best 39 growth stocks for 2022
- Subscribe for free to the ii YouTube channel for our latest share tips and fund manager interviews
- Private Investor Index: ii customers beat professional investors in 2021
Expectations prior to the update were also for a resumption of dividends, with 2.3p paid out in respect of 2021, rising to 12.6p for 2022 – apparently representing the chance currently to lock in a yield over 5%. But there was no mention of a dividend in the update (after no interim pay-out) – simply a commitment to review policy as operating markets recover.
A debt load has raised risks during Covid uncertainties
Also weighing on payouts and explaining why the stock has recently been out of favour – drifting from 250p last August to 178p mid-December – is the update’s reference to year-end net debt up 8% to $1.4 billion (£1.0 billion).
Even if this chiefly reflects a working capital outflow on Wood’s projects side, it is a big lump of debt on which the interim accounts showed a $47 million net interest charge, taking 55% of operating profit – hence Wood ending up effectively around break-even.
With the appearance of the Omicron variant last November, sentiment unsurprisingly became more cautious, given this debt is a millstone despite a new five-year facility signed last October.
But the stock leapt 25% to over 250p by early afternoon yesterday, closing up 20% at 240p, after the update cited a full sale process for the Built Environment consulting side, equating to about 20% of group revenue.
Potentially £2 billion from a disposal will slash debt
Last November, a strategic review was initiated on how best to unlock value from this business “that Wood believes is not currently recognised in its market capitalisation”. Its operations are spread over consulting and engineering, aiming to address environmental risks and increase climate resilience to enable the building of more sustainable infrastructure.
Reports yesterday cited as much as £2 billion could be raised by this sale, more than the company’s current market cap of £1.7 billion . Even if this number is on the fanciful side, a big cash injection would transform Wood’s balance sheet and radically improve the risk/reward profile.
- Investors ignore this FTSE 100 stock’s massive dividend
- 10 stocks that could protect investors from inflation
- Friends & Family: ii customers can give up to 5 people a free subscription to ii, for just £5 a month extra. Learn more
Moreover, short sellers are under increased pressure to close a total 4% disclosed short position involving four hedge funds. They have been reducing exposure since last November, with two of the four funds buying back on 4 and 7 January. They probably do not want to be exposed now that Wood’s update indicates a sales agreement for Built Environment in the second quarter of 2022.
A short trade had logic while Covid disrupted demand for Wood’s services and the balance sheet offered little protection – $6.2 billion of goodwill and intangibles constituting 145% of net assets, as of last June. But an improved macro context, as higher energy prices boost demand for services, and a disposal potentially able to transform debt change all this.
Wood is emerging out a longer-term trough besides Covid
I drew attention to Wood last June at 217p on the basis of a likely recovery in demand for oil services, and also in relation to its growing exposure to green energy projects. My reading of it having reached a trough on fundamentals was fair, albeit the timing was premature.
While Covid hit, the stock fell from around 400p in early 2020 to around 180p lows; in contrast, from 2011 to 2017 it frequently traded over 800p.
Interim results last September showed lower operating results, with the group effectively around break-even; yet there was 9% growth in the order book, with $7.7 billion of work. Increased margins were cited as a “Future Fit” programme began to deliver efficiency. There was a greater weighting to high-margin consultancy, and renewables’ work constituted 25% of revenue. Hopes were then disrupted by the Omicron variant, after Covid had already contributed to a 24% revenue decline in 2020.
But Wood’s positioning across both fossil fuel and green energy markets makes it possible now to capitalise on demand - which is better than at any time in the last two years.
I find some uncertainty as to the extent of margin improvement possible, given updates trumpet how progress has already been made towards 9% at the EBITDA level. Wood’s medium-term target is 9.6%, which effectively means the debt burden and costs have to be lifted to achieve material earnings.
John Wood Group - financial summary
Year end 31 Dec
|Turnover - $ million||5,001||4,121||5,394||10,014||9,890||7,564|
|Operating margin - %||3.2||2.2||0.5||1.7||3.1||-0.4|
|Operating profit - $m||159||89.4||27.9||165||303||-32.9|
|Net profit - $m||79.0||27.8||-32.4||-8.9||72.0||-229|
|Return on capital - %||5.0||3.0||0.3||2.1||4.1||0.5|
|Reported EPS - cents||17.3||7.3||-7.4||-1.3||10.5||-34.1|
|Normalised EPS - c||67.5||51.3||38.7||28.7||22.2||-0.3|
|Operating cash flow/share - c||123||49.5||34.2||80.9||96.4||45.1|
|Capital expenditure/share - c||21.8||22.7||18.0||13.8||21.3||13.1|
|Free cash flow/share - c||101||26.8||16.2||67.1||75.0||31.9|
|ordinary dividend/share - c||30.3||10.8||34.0||34.5||0.0||0.0|
|Covered by earnings - x||0.6||0.7||-0.2||0.0||0.0||0.0|
|Cash - $m||851||580||1,257||1,353||1,857||585|
|Net debt - $m||320||349||1,641||1,559||2,052||1,568|
|Net assets/share - c||633||576||732||674||645||606|
Source: historic company REFS and company accounts
Petrofac - financial summary
Year ended 31 Dec
|Turnover - $ million||6,844||7,873||6,395||5,829||5,530||4,081|
|Operating margin - %||-3.7||2.4||1.6||2.7||4.0||-3.6|
|Operating profit - $m||-252||186||104||159||220||-148|
|Net profit - $m||-349||1.0||-29||64.0||73.0||-180|
|Return on capital - %||-6.9||5.8||4.0||7.9||10.7||-17.1|
|Reported EPS - cents||-99||0.3||-8.2||17.8||20.5||-51.3|
|Normalised EPS - c||-60.5||81.0||119||123||57.2||-4.0|
|Operating cash flow/share - c||189||182||119||135||66.7||-4.6|
|Capital expenditure/share - c||47.8||46.2||33.1||27.3||28.3||17.1|
|Free cash flow/share - c||141||136||86.2||108||38.4||-21.7|
|Dividend/share - c||63.2||60.5||12.2||35.5||0.0||0.0|
|Earnings cover - x||-1.6||0.0||-0.7||0.5||0.0||0.0|
|Cash - $m||1,559||1,167||967||726||1,025||684|
|Net debt - $m||1,101||1,213||1,159||361||423||429|
|Net assets/share - c||342||305||258||202||176||120|
Source: historic company REFS and company accounts
Parallel assumptions being made towards Petrofac
This £730 million, small cap oil & gas services group Petrofac (LSE:PFC) rose 5% to 141p yesterday, in sympathy with Wood, but has edged up anyway from 115p at end-December.
So far this January, I have explained how the oil & gas and banking sectors have a favourable macro context (sustainably firm energy prices and interest rates set to rise), which is indeed boosting sentiment towards such stocks. Yesterday’s FTSE 100 action was led by oils and banks.
Petrofac also sports an improving order book: a 16 December update cited new order intake of US$2 billion in the year to date, up from $0.5 billion mid-year, which accorded with Wood’s latest message of momentum growth in the second half-year.
I similarly drew attention to Petrofac as a “buy” last June at 109p, so you could say my re-endorsing this stance shows an aspect of confirmation bias.
- Petrofac's path to pre-pandemic share prices
- Stockwatch: scope for double-digit yield and stock doubling?
- Stockwatch: Petrofac hits all-time low – should you buy?
What can obviously go wrong is further industry disruption, should another Covid variant materialise. Yet the pandemic is in the midst of another vigorous global wave without the implementation of lockdowns on their previous scale – except in China – which compromised demand. It appears that traders and industrialists alike are latching on to the sense that Covid will become endemic but as a milder illness.
I notice hedge funds re-positioning on the “long” side for oil & gas commodity contracts, which ought also to support firm pricing. In turn, this should unlock more fossil fuel projects while Wood and Petrofac are also reinventing themselves in a green space. So yes, I find mounting evidence to justify “buy”, despite both stocks having troubled histories (including the Unaoil bribery scandal).
At the end of last November, credit ratings agency Fitch affirmed Petrofac at B+ with a negative outlook rating; but though I understand its caution, I find credit ratings agencies prone to a “rear view mirror” perspective. Fitch argued that “the decline in new orders is a key rating risk,” but the order book is manifestly rising.
Do not be afraid sometimes to counter heavyweight views!
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.
We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Where relevant we have set out those particular matters we think are important in the above article, but further detail can be found here.
Please note that our article on this investment should not be considered to be a regular publication.
Details of all recommendations issued by ii during the previous 12-month period can be found here.
ii adheres to a strict code of conduct. Contributors may hold shares or have other interests in companies included in these portfolios, which could create a conflict of interests. Contributors intending to write about any financial instruments in which they have an interest are required to disclose such interest to ii and in the article itself. ii will at all times consider whether such interest impairs the objectivity of the recommendation.
In addition, individuals involved in the production of investment articles are subject to a personal account dealing restriction, which prevents them from placing a transaction in the specified instrument(s) for a period before and for five working days after such publication. This is to avoid personal interests conflicting with the interests of the recipients of those investment articles.