After an opportunistic takeover approach fizzled out last May, the mid-cap engineering and consulting services group John Wood Group (LSE:WG.) has made fair underlying progress – despite its stock in the 150p area remaining well below 225p in April when a deal was anticipated.
Recent interim results had improving elements if continuing to reflect a radical split between adjusted and reported numbers. Also, free cash flow was negative versus the promise of it becoming positive this year as a whole.
But latest news of a $330 million (£261 million) strategic partnership with Harbour Energy (LSE:HBR), the UK’s largest oil & gas producer, underlines Wood’s competitiveness. Running for an initial five years, it will not please eco-warriors, but if you take the view that North Sea supplies are preferable to imported energy in the overall transition towards green sources, Wood is making its contribution.
It follows a multi-year agreement with Shell (LSE:SHEL) last month, extending a 70-year international relationship and helping Shell “deliver energy transition at pace”.
The first half-year did show sustainable energy work up 20% to constitute 20% of revenue, or 33% of the sales pipeline. All business units achieved growth.
As a multinational engineering and consulting group headquartered in Aberdeen, energy services will always be key – but Wood also has clients in materials markets.
Stock recovering steadily after failed private equity bid
Wood jumped from a 140p range in February to over 200p as Apollo private equity made a series of possible cash offers up to 240p a share. All were rejected by the board and its advisers, which implicitly involved consulting with lead shareholders.
Capitalised near £1.1 billion with its stock currently 157p, Wood trades on 17 times consensus for earnings per share (EPS) of 7.4p equivalent this year, easing to 13 times if 12p is achieved in 2024 – with net profit expected to climb to $114 million, or £90 million equivalent. There is no dividend - even forecast - versus 34p per share five years ago, and a goodwill/intangibles-swollen balance sheet means negative net tangible assets of 95p per share. Combine such financials with a fairly complex narrative as a major engineering group, and it is hardly surprising that few regard Wood as a conviction stock.
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Yet it remains well down from a 600-800p range between 2010 and 2018, with a new CEO effective July 2022 who set out a growth strategy last November. Admittedly, Wood has divested its Built Environment consulting side that contributed $57 million of adjusted post-tax profit in the first half of 2022, hence the historic chart is rather compromised. But Apollo’s approach affirmed a sense that now is broadly the time to invest in Wood, despite uncertainty about whether higher interest rates belatedly cause an economic slowdown.
In other macro variables affecting this group, OPEC’s recent ability to ratchet up oil prices – with output cuts – shows it is on the ball and managing the market. While adding to stagflation risks, it does offer producers a relatively attractive environment in which to commit project spending, which should benefit servicers.
Multiple share acquisition prices reflect belief in value
When I made a “buy” case at 115p last October, the stock had continued to drop despite cluster buying by directors after the August 2022 interim results. The CEO bought £235,000 worth at 138p, the strategy and development director £45,000 worth at 129p, and three non-executive directors a total £36,000 worth at prices of 145p down to 125p. That established a clear benchmark for their belief in value.
There has not since been anything like the same cash buying, but senior management have been getting share awards, which at least adds an incentive. Yesterday, for example, the CEO was granted 50,000 shares at nil value, although on 22 August a non-executive director did buy an initial 13,000 shares near 158p.
This compares with Apollo’s series of “possible” cash offers last springtime, culminating in 240p per share.
And last June, investment giant Fidelity raised its stake from 5.2% over 9.5% when the market price was around 130p – the stock having slumped in May after Apollo backed off. That implies a commitment of over £46 million.
Cash flow profile is crux as to Wood being in the clear
Together with the reported/adjusted, earnings split, it reflects legacy issues – and has needed to improve for dividends to be restored.
Last November, the market was unimpressed by an update saying it would take until 2024 to return to positive free cash flow, hence the stock dropped from 160p to around 130p.
For example, the 2022 cash flow statement reflected a need for higher tax payments and cash applied to cut trade payables.
In the first half of 2023, adjusted operating cash flow of $39 million turned around from $82 million negative, although free cash flow was still heavily negative at $219 million (if improved from $352 million) said due to “phasing of exceptional cash outflows”. Within working capital, receivables also jumped by $164 million from $32 million.
You have to assume management’s projections for such are behind guidance for positive free cash flow in 2024.
John Wood Group - financial summary
Year end 31 Dec
|Turnover - $ million||5,001||4,121||5,394||10,014||9,890||7,564||5,238||5,442|
|Operating margin - %||3.2||2.2||0.5||1.7||3.1||-0.4||-1.2||-10.4|
|Operating profit - $m||159||89.4||27.9||165||303||-32.9||-62.1||-568|
|Net profit - $m||79.0||27.8||-32.4||-8.9||72.0||-229||-139||-356|
|Return on capital - %||5.0||3.0||0.3||2.1||4.1||0.5||-0.9||-10.8|
|Reported EPS - cents||17.3||7.3||-7.4||-1.3||10.5||-34.1||-32.2||-104|
|Normalised EPS - c||67.5||51.3||38.7||28.7||22.2||-0.3||-11.2||-1.4|
|Operating cash flow/share - c||123||49.5||34.2||80.9||96.4||45.1||-8.8||-53.0|
|Capital expenditure/share - c||21.8||22.7||18.0||13.8||21.3||13.1||17.0||20.1|
|Free cash flow/share - c||101||26.8||16.2||67.1||75.0||31.9||-25.8||-73.1|
|Ordinary dividend/share - c||30.3||10.8||34.0||34.5||0.0||0.0||0.0||0.0|
|Covered by earnings - x||0.6||0.7||0.0||0.0||2.0||0.0||0.0||0.0|
|Cash - $m||851||580||1,257||1,353||1,857||585||491||522|
|Net debt - $m||320||349||1,641||1,559||2,052||1,568||1,855||751|
|Net assets/share - c||633||576||732||674||645||606||590||539|
Source: historic company REFS and company accounts.
Half-year results raised guidance but had soft elements
Interim results remained quite messy and complicated to decipher – using the typical measure of adjusted EBITDA to proclaim a 12% profit advance on revenue up nearly 20%. Reported operating profit eased 26% to $23 million, although various hefty depreciation and amortisation charges continue.
Full-year guidance was raised amid confidence in actions being taken and the pipeline of work, hence “momentum building”.
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A 5% increase in the order book (since December) at constant currency could, however, be viewed as flat at best, adjusting for inflation. By 30 June, it was indeed flat at $2.1 billion, or up 2% at constant currency.
And while revenue is expected to continue to grow in the second half, it will be at a lower rate than the first half.
Thus, a dilemma is whether to put faith in the overall turnaround or be alert to elements softening as straws in the wind of global slowdown.
Against $450 million end-June cash, there was $1,104 million financial debt and $326 million leases, which meant a $43 million interim net finance charge, hence a $15 million normalised operating loss.
How well will global economy muddle through?
Softening demand and “higher interest rates for longer” are liable to mean Wood needs patience as a turnaround play. If the macro story turns more towards recession, it will not help, requiring OPEC also to cut production further if it wants to sustain prices. At least Wood, like other energy servicers, is ramping up its work on de-carbonisation.
I therefore broadly retain a “buy” stance, respecting progress with the turnaround plus further mileage. It is an edgy call given macro risks, but with OPEC showing better co-ordination and the prospects for green energy solutions, Wood’s risk/reward profile remains favourable. Buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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