Interactive Investor

Stockwatch: more investors might appreciate this Marmite share

11th April 2023 11:08

by Edmond Jackson from interactive investor

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This small-cap company has been a volatile investment, but analyst Edmond Jackson believes changes taking place might broaden its appeal.

Marmite share 600

Might this finally be a turning point on a poor long-term chart for this near-£400 million energy industry services group? 

Petrofac (LSE:PFC) shares nearly doubled from a 46p all-time low, then settled at around 72p currently after a potentially transformative 30 March announcement. Partnering with Hitachi Energy, the duo has been awarded a €13 billion (£11.4 billion) multi-year framework agreement by TenneT as it expands wind farms in the Dutch-German North Sea. 

That could see Petrofac gain around $1.2 billion (£965 million) annually over six years, and past annual reports have cited targeting gross margins of 5% or better. 

It is a sensitive development for two reasons. First, as proof to creditors the business is attractive despite Covid disruption and other issues swinging the group into losses. Second, it is a big endorsement of Petrofac’s capability to serve green energy. 

A series of likely contracts

The news underlines elements of an update last 20 December, which cited a “backlog” down from $3.7 billion last June to $3.3 billion at year-end, reflecting industry delays to contract awards. 

On the engineering and construction (E&C) side, $1.5 billion of opportunities were at preferred bidder state and a further $3.5 billion bids submitted.  

The company said: “We expect these opportunities to provide backlog growth in 2023 and lay the foundations for a return to profitability, positive free cash flow and continued recovery thereafter.” 

It is Petrofac’s E&C side that will build offshore wind platforms and elements of onshore converter stations, for TenneT. “A healthy E&C pipeline of $54 billion is scheduled for award in the next 18 months.” 

Petrofac - financial summary
Year end 31 Dec

Turnover - $ million6,8447,8736,3955,8295,5304,0813,057
Operating margin - %-
Operating profit - $m-252186104159220-160-130
Net profit - $m-3491.0-2964.073.0-192-195
Return on capital - %-
Reported EPS - cents-990.3-8.217.820.5-54.8-53.9
Normalised EPS - c-60.581.011912357.2-1.7-24.3
Operating cash flow/share - c18918211913566.7-8.6-44.5
Capital expenditure/share - c47.846.233.127.328.313.114.6
Free cash flow/share - c14113686.210838.4-21.7-59.1
Dividend/share - c63.260.512.
Earnings cover - x-1.60.0-
Cash - $m1,5591,1679677261,025684620
Net debt - $m1,1011,2131,159361423429395
Net assets/share - c34230525820217111291.4

Source: historic company REFS and company accounts.

New CEO has taken the reigns

A new chief executive offers aspects of a managerial fresh start. Tareq Kawash joins from McDermott where he was senior vice president of its onshore and offshore business, with 30 years international Engineering, Procurement, and Construction (EPC) experience. It is, however, his first time as CEO of a listed plc. 

That a 22 November announcement cited his predecessor to step down and leave the company may have created trepidation about messy 2022 annual results, hence the stock falling from around 80p below 50p this year. 

Results are scheduled for 25 April, about a month later than 23 March last year. 

The context was set by the “story of two sides” trading update on 20 December, where performance by asset solutions and integrated energy services offset E&C, which faced ongoing cost recovery challenges.  

Covid extended schedules resulted in cost over-runs, but at least on the problematic E&C side five of a remaining eight mature contracts are scheduled to complete this year. 

It meant guidance was set for a circa $100 million 2022 loss at the operating level in context of $2.5 billion revenue. 

Mid-range expectations are for net losses to continue, if nearer $150 million after close to $200 million annually in 2020 and 2021. The fully-diluted earnings per share (EPS) loss could be over 30 cents, then a 5 cents loss before 7 cents or possibly more in 2024. 

In sterling terms, if around 6p is achieved from 2024, the prospective price/earnings (PE) multiple would be 12 times. 

While the board has committed to dividends resuming when possible, nothing material can yet be projected. 

Net tangible assets per share equivalent to 54p 

I believe another reason the stock has proven sensitive to good commercial news was it trading below net tangible asset value when down at 46p. 

The 30 June 2022 balance sheet had $482 million of net assets, of which 27% constituted goodwill/intangibles, implying £284 million equivalent net tangible assets, or 54p per share.  

Petrofac made modest fixed asset impairments at the half-year stage but has not guided for anything material extra.  

If the commercial context is improving and debt can be managed, this asset base helps tilt the risk/reward profile positively.  

It also has better substance than swollen intangibles at peer company John Wood Group (LSE:WG.). which is subject to a private equity bid approach. 

There appears a parallel – in terms of the energy services business cycle – how Wood is now a takeover target and Petrofac anticipates contract awards improving. 

Debt concerns persist 

The mid-2022 balance sheet had $722 million of long-term debt and $49 million short-term, plus $91 million other financial liabilities. That’s in context of $430 million cash, hence $432 million net debt relative to $482 million net assets. 

Rising interest rates would appear the culprit for the interim interest charge up 160% to $44 million, there being only $1 million of finance income. 

This also explains the stock volatility amid recent fears of a recession giving way to hopes for green energy, but, admittedly, a stagflation scenario would mean an ongoing hurdle. 

Last December’s update cited $396 million net debt, though it’s unclear quite whether this includes “other financial liabilities”, reflecting a delay in some receipts also cost over-runs. 

It said: “We have engaged with our lenders to extend the revolving credit facility and a bilateral loan – totalling $230 million – scheduled to mature this October.” 

Logic suggests an improving commercial profile would help. However, re-jigging debt can mean a sting of fees. 

Short-sellers have pointed out, Petrofac’s 9.75% bond issued in 2021 has traded well below a circa 80% discount level, which historical studies have shown is a sign of distress and where a company may struggle to repay debts. 

Yet, as of last September, around a third of the UK’s supposed safest corporate bonds traded below such a discount amid confusion over government policy, and it remains a feature of various bonds. 

I would pay more attention to whether credit rating agencies upgrade Petrofac after its 2022 results and in a more positive contracting environment. Cash tends to be provided up-front by clients, towards tooling up etc, hence the company should not end up “over-trading” relative to its finances, if work does soar. 

Mind, credit rating agencies can be well behind the curve relative to the stock market sensing change in risk. 

Last October, Fitch had a B+ issuer default rating, with a negative outlook due to weak order backlog in E&C against high debt levels. The agency still noted a strong overall market position and healthy geographic diversity.  

It said: “We assume that its strong pipeline of opportunities will gradually translate into increased E&C profitability, leading to an improved leverage profile.” 

Logically, and assuming no major recession, the odds will be on Fitch gradually improving its rating. 

Short-sellers linger despite landmark wind farms deal 

Overall, 3.7% of Petrofac’s issued share capital (disclosures over 0.5%) is out on loan: 

On 4 April, Astaris Capital Management increased its short 0.10% to 0.65% of the issued share capital, then on 5 April Qube Research & Technologies raised its 0.11% to 0.62%.  

GLG Partners has made no change to its 0.60% short as of 15 March, likewise Pictet Asset Management, short of 0.52% on 24 March. 

Yet following the 30 March framework agreement news, on 4 April Kairos Investment Management eased its short 0.09% to 0.69% and Systematica Investments also reduced 0.07% to 0.59%.  

Take your view on a Marmite situation 

In a tough stagflation scenario, with interest rates remaining high, Petrofac may continue to struggle.   

But if recession is avoided, contracts build and the stock is increasingly seen as a green energy play, a case now exists for a starter position. Buy. 

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

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