Stockwatch: A possible turnaround and 6.7% dividend yield

A robust trading update could re-energise this high-yielder, believes companies analyst Edmond Jackson, who rates the shares a speculative buy.  

Can mid-cap oil & gas construction/services stock Petrofac now shake off a steep fall in oil prices, re-affirm prospects and trigger a rebound?

A trading update is due later this week or beginning of next.  I've favoured Petrofac from around 400p after a plunge from 950p to 350p in April 2017 due to a Serious Fraud Office inquiry into bribery allegations surrounding Unaoil, a Monaco-based oil consultancy.  

The rationale is that this affected plenty more companies than Petrofac and its clients would put most emphasis on capability in oil & gas services and engineering/procurement/construction (EPC) contracts.

Having read so many Private Eye columns on the "Serious Farce Office" since my schooldays, this episode would more likely proceed to form, i.e. the stockmarket initially over-reacting, then the SFO taking so long to come to any conclusion, investors would regard the episode as history.

Certainly, oil prices have proved a more dominant influence.  Petrofac recovered usefully to twice test a 660p area last summer, which coincided with OPEC showing better discipline to maintain production cuts and oil traders jumping on the bandwagon to push Brent prices up to $85 a barrel.

Source: TradingView (*) Past performance is not a guide to future performance

This made sense given larger EPC contracts tend to be more profitable than regular oil & gas servicing, but are oil price-sensitive.  Thus, the stock has slumped nearly 30% to 465p relative to a 33% fall in oil prices, seemingly indifferent to a 5% rebound in oil prices last Friday after OPEC and a coalition of other oil producers agreed a production cut.  Even those analysts wary this will create much oil price recovery, given an apparent glut, suggest prices should at least stabilise.

Uncertainties make for a 6.7% prospective yield

The big macro question is whether oil’s plunge reflects a fundamental shift in global demand as the business cycle possibly turns down, hence could manifest further in 2019.  This is possible if trade conflicts escalate and weak growth signals, which I noted in my end-November macro review, spread further.  But remember how the end-2014/early-2015 plunge in oil prices prompted far worse warnings, for example of deflation, proven wrong.

Uncertainties abound but, given Petrofac's end-August interims effectively affirmed the market forecast for a dividend payout around 31.3p (on a 12-month forward basis), then the stock now yields a supportive 6.7% versus 4.70% at the mid-year peak. 

Such a yield is not only useful to lock into at around present market price, it offers capital upside once the stock's risk profile improves.  Even if the SFO ultimately slaps on a fine and public reprimand, unless it's so bad as to require the CEO's resignation, then the stock is likely to trade higher given an uncertainty would be removed.

My judgment is oil prices and the global economy being far more significant -  a cocktail of European troubles now adding to the US/China trade stand-off.  A 5.5% prospective yield might be considered a base level proxy for risk, i.e. a share price ceiling of 575p in the short to medium term, and still a useful target if management can re-affirm progress in its pre-close update due soon.

Source: Company REFS      Past performance is not a guide to future performance

Balance sheet underwrites medium-term dividend policy

In August, the company (reporting in US dollars) declared an interim dividend equivalent to 10p per share, in line with a policy for the interim payout to reflect about 33% of the total prior year dividend.

The 31.4p projected (see table) would cost £107 million in context of the end-June balance sheet showing £560 million equivalent cash, although mind how the interim cash flow statement only tilted positively due to £40 million from disposals to help offset £331 million accrued contract expenses.

That's not untypical for a lumpy contracting business; why a cash buffer is maintained.  It has been bolstered by last October’s completion of the sale of 49% of Petrofac's Mexico operations for £157 million to £215 million equivalent, subject to performance.

Second-half revenues would appear broadly secure

Switching to a US dollar perspective for revenue comparisons: at the end-August interims, management said it had a healthy order backlog (estimated revenue from work in progress) of $9.7 billion at end-June, versus $10.2 billion at end-December and with $3.3 billion new order intake for the year to date.

The outlook statement cited $3 billion secured revenue for the second half (e.g. news of a $600 million EPC contract in Algeria, same day as interims) which, in comparison with $6.4 billion annual revenue in 2017, came across as if 2018 was broadly secure.

Yet there was ambiguity between "new order intake of $3.3 billion year to date which in results date context included three contract announcements in July/August.  Since the end-August interims there has only been 19 October news of an award relating to a consortium with Saipem and Samsung, to transform a Thai oil refinery, involving a $1.4 billion revenue share for Petrofac.  While substantial the revenues will be spread over four years.

If the RNS tally is any guide to underlying momentum, the 2018 half-years look in balance: Petrofac declaring four contracts in respect of H1, then a 10 July Dutch offshore wind contract and a 13 August Basra EPC contract. Together with the Algerian contract, this presumably helped justify the $3 billion "secured revenue" management was asserting for H2 at interims – the Thai deal then building further on this.

It would, therefore, appear Petrofac is on course, if a concern how there's been no progress declared since autumn, which coincided with the plunge in oil prices that could have stalled closure on EPC deals.  In this scenario, the OPEC agreement ought now to herald more by way of contract news.

The interims had asserted "strong operational performance across the group with net business performance profit up 20% to $190 million", despite an 11% slip in revenue to $2.8 billion (linked to project phasing).  There was a split between reported and underlying profit however: a reported net loss of $17 million due to impairments/exceptional items of $207 million.

Yet the share price grinds lower

This week hasn't started best - a 10p slip to 465p - while Wood Group is flat at around 625p after rallying from 600p in reaction to OPEC's news. Meanwhile, oil exploration/production stocks rallied last Friday, in response. 

"Don't fight the tape!" (go with the trend) sentiment looks as if prevailing towards Petrofac, but, unless contracts have fallen by the wayside, its stock ought now to be in buying territory.

There has previously been a pre-close update around 15 December and this year's could create an inflection point if it affirms expectations.  If not, then Petrofac will head lower but, as things stand, a robust update looks able to create a turnaround.  Your risk appetite determines whether to await the evidence. Speculative buy.

*Horizontal lines on charts represent levels of previous technical support and resistance. Trendlines are marked in red.

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