Interactive Investor

Stockwatch: this share’s record low might interest risk-takers

23rd December 2022 08:53

by Edmond Jackson from interactive investor

Share on

Does news of setbacks mean that energy service stocks are no longer a buy? Analyst Edmond Jackson assesses the circumstances and a battle between acquisitive directors and short-sellers.

Despite stabilising after a Serious Fraud Office investigation, with top management replaced, the chart for Petrofac (LSE:PFC), a circa £350 million oil and (increasingly) green energy services stock, has plunged as low as 65p from 125p only a month or so ago. 

Recalling the context

Until last Tuesday, there had not been a trading update since the August interims showed near break-even at the operating level on underlying revenue down 23% to $1,228 million (£1,008 million). A $14 million overall net loss was struck, and the backlog (or work-in-progress) had eased from $4.0 billion to $3.7 billion over the six months to end-June.  

A $193 million free cash outflow (hence no interim dividend payout) meant net debt had soared from $144 million to $341 million over the period. But Petrofac was in compliance with its banking covenants at end-June and had $511 million liquidity to give clients confidence on project delivery. 

Management blamed Covid-related industry challenges for the numbers, with things looking up. It said: “The market outlook for Engineering and Construction continues to improve and we are optimistic that the opportunities we are bidding on will start to be awarded in the second half of the year. E&C has a $45 billion, 18-month pipeline of opportunities...” 

Petrofac - financial summary
Year end 31 Dec

2015201620172018201920202021
Turnover - $ million6,8447,8736,3955,8295,5304,0813,057
Operating margin - %-3.72.41.62.74.0-3.9-4.3
Operating profit - $m-252186104159220-160-130
Net profit - $m-3491.0-2964.073.0-192-195
Return on capital - %-6.95.84.07.910.8-19.2-8.0
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 - c63.260.512.235.50.00.00.0
Earnings cover - x-1.60.0-0.70.50.00.00.0
Cash - $m1,5591,1679677261,025684620
Net debt - $m1,1011,2131,159361423429395
Net assets/share - c34230525820217111291.4

Source: historic company REFS and company accounts

Sudden news of CEO departure prompted short-selling 

On 22 November, it was announced the CEO of just two years will leave at the end of March 2023 “to pursue other interests”. His successor, who joins from McDermott International, a global provider of engineering and construction solutions to the energy industry, said he looks forward to “building on the excellent progress,” and the departing CEO added: “After an intense period, Petrofac is today in a stronger position.” 

In terms of validity of watching short-seller data, four institutional traders proceeded to raise their disclosed short positions (over 0.5% of Petrofac’s issued share capital) The total disclosed extent rose from 1.7% on 22 November to 4.5% as of 19 December. 

On 25 November, Schroders also reduced its stake from 14.7% to 9.5% but this involved a sale chiefly to Azvalor Asset Management of Spain, which doubled its holding to 10.0%.  

Update reveals $100 million group loss for 2022  

In last Tuesday’s trading update, a circa $190 million operating loss on the E&C side was said to be mitigated to around $100 million at the group level: “reflecting adverse commercial settlements, further unrecovered cost over-runs in the legacy portfolio and cost increases on the Thai Oil Clean Fuel joint venture project.” 

It compares with prior market consensus for a $7 million net loss. 

Management maintains: “a positive outlook for the recovery in E&C and continued growth in Asset Solutions, with $68 billion scheduled for award in the next 18 months.” 

Net debt was $396 million at 15 December, with cash management partly offsetting delays in E&C contract awards and unrecovered cost over-runs in the E&C legacy portfolio during the second half. 

The stock swiftly fell 10% to 65p as interpretations weighed negatively, yet maintained that level. Petrofac carries substantial debt for its size and will need to refinance it next October at what must be higher interest rates. In a worse-case scenario, bankers could insist on a capital restructure – i.e. a dilutive equity-raising while the stock is at record lows. There are already over 521 million shares issued. 

Three insiders buy nearly £900,000 worth of stock at the low  

Later Tuesday afternoon, it was disclosed how Petrofac’s founder, chairman and even the out-going CEO had bought a total 1,370,000 shares at around the market lows, helping the price sustain a recovery to about 70p. 

My respecting much earlier purchases by insiders admittedly did not result in a secure medium-term investment. I rated  Petrofac “buy” at 109p in June 2021, which worked well given a rally over 170p that October, but volatile-sideways trading persisted until the drop from 125p a month or so ago. 

It is unclear quite whether company-specific factors are to blame or the real problem is inherent risk of cyclical industries at the early stage of economic downturn.  

Yet energy markets appeared to be recovering from Covid disruption, war in Ukraine propped prices, and demand for green energy services had appeared a firm industry context. 

The sector is not immune to current industrial unrest: what was not in Tuesday’s update was a two-day strike a month ago, led by the Unite union, which argued Petrofac has not delivered on reviewing a 10% pay cut for staff in 2020. 

Prospects appear to hinge on whether a global recession ensues, making it harder even for a capable new CEO. Aggressive insider buying versus a determined posse of short-sellers shows the scope for radically diverging views. I retain a “buy” stance around 70p currently, but know your risk appetite here.

A read-across to John Wood Group 

Shares in John Wood Group (LSE:WG.), a circa £870 million servicer, initially fell in sympathy from 126p to 122p, but recovered through Tuesday to close at 128p and have risen further to 132p. It still continues a downturn from 160p in late November. 

I have similarly advocated Wood equity, where last October I noted five directors had bought £315,355 worth of shares since August’s interim results – in particular, a relatively new CEO snapping up £234,600 worth at 138p. 

I thought that at 115p Wood merited a “buy” stance, as one to consider averaging into. 

The consensus has been more bullish than for Petrofac: Wood expected to make $118 million net profit in 2022 hence a rebound in earnings per share (EPS) to 9.6p equivalent and 13.3p in 2023 – for a price/earnings (PE) multiple of 12.9x, easing to 9.3x. If a 5.2p equivalent dividend per share is paid in respect of 2023, the yield would be 4.2%. 

John Wood Group - financial summary
Year end 31 Dec

2015201620172018201920202021
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 - c67.551.338.728.722.2-0.31.1
Operating cash flow/share - c12349.534.280.996.445.1-8.8
Capital expenditure/share - c21.822.718.013.821.313.117.0
Free cash flow/share - c10126.816.267.175.031.9-25.8
Ordinary dividend/share - c30.310.834.034.50.00.00.0
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 - c633576732674645606590

Source: historic company REFS and company accounts

On 29 November, management held a capital markets day to explain its refreshed strategy, taking “a more focused approach to growth, targeting specific priority markets across energy and materials that best match our competitive strengths. This tighter focus will help ensure we can grow both profitably and sustainably.” 

You could say management should be doing that anyway. 

They proclaim the group is “transformed...well-positioned for growth” – serving oil & gas and chemicals, also hydrogen and carbon capture, minerals and life sciences. 

Yet not unlike Petrofac, operating margins will be flat in the near term due to investment to secure growth. 

“In the medium term, we see opportunity for some margin improvement” leading to single-digit operating profit growth. Mind, Wood’s specific reference is to “adjusted EBITDA” which is near operating profit – but at low single-digit percent growth, could mean (near) flat profit or worse. 

Combined with reducing legacy liabilities, a return to positive free cash flow is entertained from 2024 onwards. 

It seems wise to take such projections with a pinch of salt, given rising risks of a global recession. 

At some risk of being tactically premature with an industrial cyclical, I maintain: Buy.

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.

Disclosure

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.

Get more news and expert articles direct to your inbox