Interactive Investor

Stockwatch: one to buy if a bid approach fails

This company has attracted another takeover bid just a year after a previous round of talks with a different suitor came to nothing. Analyst Edmond Jackson explains how he’d play the current situation.

10th May 2024 11:49

by Edmond Jackson from interactive investor

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Is mid-cap John Wood Group (LSE:WG.) becoming the latest overseas takeover victim to signal the undervaluation of UK equities, or another “possible offer” hoax like at Currys (LSE:CURY) recently.

This engineering and consulting group - serving energy and materials - confirmed last Wednesday it had received a possible cash offer at 205p per share from Sidara, a Dubai-based consultancy. It was rejected as undervaluing Wood and its prospects, Sidara declined to comment and, according to takeover rules, it has until 5pm on 5 June to confirm its intent. Market price which initially jumped close to 200p is currently 193p.

In a medium-term context, the approach looks timely as the stock price chart forms something of a bullish “bowl” pattern after declining from over 550p five years ago:

John Wood group chart

Source: TradingView. Past performance is not a guide to future performance.

Going back to 2010-16, Wood was even in a 560-880p range, although the 2017 acquisition of rival Amec Foster Wheeler for £2.2 billion caused more trouble than it was worth, for example a bribery and corruption probe.

Join the dots of different people identifying value

It struck me that underneath the woes were some worthwhile businesses and, if a CEO was capable of restructuring, then the main investment challenge was timing. I drew attention as a “buy” at 115p in October 2022 after the directors had bought over £300,000 worth of equity since the August interim results. War in Ukraine had dealt a blow to cyclical stocks, but the CEO cited a strong order book and disposal of the built environment consulting side had raised £1.5 billion.

This was followed in early 2023 by a series of takeover approaches from US private equity group Apollo. It raised its “possible” terms to 240p per share then backed off after Wood opened its books. In hindsight this was a distraction because private equity wants to buy as low as possible to later sell on, whereas an industry operator (like we see now) is potentially more committed, and it might pay higher if synergies are identified.

The market quite assumed there was something fundamentally flawed with Wood, hence the stock bumped along in 130-175p range last year. This latest approach is a reminder of pricing inefficiencies, however, and a year or so on Wood’s inherent “exceptionals” are likely reduced. Renewed war in the Middle East has firmed energy prices, which tends to boost demand for its services. 

A weak point with this approach is its obvious opportunism at 205p, given Apollo kicked off at 200p and the business has since evolved. Listed companies do attract chancers, it so happens the media got wind of this one. So, be careful assuming this is anything special or inevitable. The bar could now be at least 250p per share for Wood to allow due diligence – given the 2023 accounts show $5 million spent on dealing with Apollo.

Another “value dot” has been Wood’s CEO buying £564,000 worth of shares last month at prices of 129p to 150p once outside the restricted period after the 2023 results.

Upturn promised after messy 2023 results

Wood stock dropped from 148p to 127p after publication of annual results amid divided views. A shock element was a 39% hike in long-term debt to $812 million (and such lease liabilities also up 22%), which was not adequately explained after the “built environment” consulting side (ex-Amec) was sold for around $1.9 billion – a remarkable £1.5 billion equivalent – in 2022, with an agenda to cut debt.

Remarkably, management guided for “lower end-2024 debt after expected proceeds from planned disposals”. This is in context of a balance sheet groaning with goodwill/intangibles – 119% of net assets as of last December. Despite $434 million cash, net current liabilities were $207 million net current liabilities and a current ratio of 0.9.

Revenue from continuing operations was broadly in line with guidance, up nearly 9% to $5,901 million. “This growth shows the demand that is in our markets for the consulting and engineering services we provide.”

Profitability was a mixed picture: up from $93 million to $114 million albeit still a raft of exceptional items totalling $77 million; next an $89 million net finance charge and an $11 million exceptional finance expense, meaning normalised pre-tax profit of $25 million but a $63 million reported loss. After taxation and losses from discontinued operations the normalised net loss was $40 million and reported loss $105 million.

There was some fretting in the market about how free cash flow remained negative, albeit reducing from $704 million to $265 million – in a context where net debt had risen 49% to $1,094 million including leases and by 77% to $694 million excluding leases.

At least there was a $260 million improvement in adjusted operating cash flow to $194 million, helped by better working capital management. “Significant free cash flow” is expected from 2025 with the help of cost cutting and reducing exceptional cash outflows. You can perhaps see why the CEO zealously bought into the market drop below 130p per share.

He certainly put his money behind describing Wood as being in the first of a three-year growth strategy – as if a recovery phase is completing (which also accords why the company is a takeover target).

The CEO said: “We continue to see clear business momentum, with a higher order book, double-digit growth in our pipeline...the fastest growing parts of Wood are the higher-margin consulting business and sustainable solutions...”. Guidance is raised “towards the top end of our medium-term targets and we expect to exceed 2025 targets...”

The story remains mixed, however, at least short term. A first-quarter trading update yesterday showed an improvement in the order book – to 9% ahead on March 2023, compared with 7% ahead when final results were reported on 26 March. Yet revenue slipped 6% amid mixed divisional performance, one of three resulting from strategic shift.

After four years of substantial losses the market consensus looks for $47 million net profit this year and $119 million in 2025, generating normalised earnings per share (EPS) of around 4.7p equivalent, rising to 12.9p – hence a forward price/earnings (PE) multiple of 41x easing to 15x. I notice the consensus numbers have eased since Wednesday’s update but could include someone commencing coverage cautiously.

A very minor dividend is targeted in respect of 2025 and Wood could be some way from meaningful dividends, hence its stock remaining volatile should this bid approach falter. The market may, however, wake up to a trend of how Wood clearly has “worth to a private owner” for a second time in a year at over 200p per share.

John Wood Group - financial summary
Year end 31 Dec

201320142015201620172018
Turnover ($ million)5,7536,5745,0014,1215,39410,014
Operating margin (%)6.37.63.22.20.51.7
Operating profit ($m)36549715989.427.9165
Net profit ($m)29632279.027.8-32.4-8.9
IFRS earnings/share ($)0.700.930.17-0.07-0.010.09
Normalised earnings/share ($)0.770.740.680.510.390.29
Operating cashflow/share ($)1.031.231.230.490.340.81
Capital expenditure/share ($)0.360.290.220.230.180.14
Free cashflow/share ($)0.670.931.010.270.160.67
Dividend/share ($)0.220.280.300.110.340.34
Covered by earnings (x)3.13.30.60.7-0.20.9
Net debt ($m)3253273203491,6411,559
Net assets per share ($)6.56.86.35.87.36.7

Source: historic company REFS and company accounts.

200 job cuts planned

An insider-sourced story that got into the press was a plan to cut a further 200 jobs. Wood already cut 34 UK-based jobs in February, including 22 at the Aberdeen head office. As with the message of “further disposals planned” to cut debt, the drive to make Wood free cash flow generative begs the question if muscle is being trimmed as well as flab.

Wood is therefore quite another of those “wall of worry” stock stories, where if you want things clean then look elsewhere. The crux for me is whether energy prices remain firm, most especially if a recession is avoided (or the effects of higher interest rates finally manifest later this year).

I do not have risk appetite to bet on a takeover contest emerging but draw your attention more conservatively to a potential “buy” should the stock drop on an aborted approach. Hold.

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

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