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Petrofac - Order book still shrinking

Nicholas Hyett | 28 August 2019 | A A A
Petrofac - Order book still shrinking

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Petrofac Ord USD0.02

Sell: 129.00 | Buy: 129.70 | Change 1.00 (0.78%)
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Petrofac reported revenues of $2.8bn in the first half, up 1.3% year-on-year. However, an increase in less profitable contracts, cost overruns and higher taxes dented margins, with net profits down 19.4% at $154m.

The board announced an interim dividend of 12.7 cents per share, in line with last year.

The shares fell in early trading.

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Our view

Petrofac's been making the most of a tough situation. Revenues have held up despite the ever shrinking order book, and good cost management has kept margins relatively healthy. First half results were actually better than analysts had feared.

Unfortunately less work coming down the pipeline is starting to restrict management's room for manoeuvre.

In the short term lower oil prices and a series of lower margin contracts in the core construction businesses mean margins are under pressure. And the shrinking order book looks set to exert pressure on revenues from 2020. Even the best management team will struggle to grow profits if there are no projects to work on. All in all a pretty gloomy outlook.

If management are to brighten things up it's vital the group starts to reel in new business. There have been some notable wins this half, especially in the North Sea, but not enough to offset work that's been completed.

With $13bn of projects up for grabs in the second half of the year alone, there's plenty of opportunity to replenish the pipeline. Unfortunately converting leads to contracts has been a struggle recently. While no charges have been brought against either the company or any current employees we suspect the ongoing Serious Fraud Office (SFO) investigation is a major factor. Management comments suggest that's particularly true in the key Saudi Arabian and Iraqi markets.

Petrofac would likely face a significant cash fine were it found to be at fault, and that would raise questions about the sustainability of the dividend, despite the debt free balance sheet. That probably explains why the stock currently offers a prospective yield of 8.1%. Investors are worried the cash could dry up at short notice.

Putting the SFO investigation to one side - which is essentially out of the company's hands now anyway - the key near term test is whether the order book can return to growth over the next 6-12 months. That relies on customers putting the SFO investigation to one side too.

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Full Year Results

The Engineering & Construction (E&C) business saw revenues rise 2% to $2.3bn and net profits fall 16% to $148m. The division won $1.6bn of new contracts during the period including projects in Algeria, Oman and the Netherlands.

Engineering & Production Services (EPS) delivered revenues of $0.4bn in the half, up 4%, with net profits of $23m down 15%. The business won $0.4bn worth of new contracts.

Integrated Energy Services (IES) revenues fell 27% to $99m - although that was driven by disposals, without which revenue would have risen 5%. The underlying growth reflects higher average realised prices and increased production. Reported net profits fell 56% to $7m, although excluding the effect of asset disposals that would represent 147% growth.

The total value of the order book fell from $9.6bn at the start of the year to $8.6bn at the end of the first half. E&C and EPS both saw total back log decline. The group is pitching on $13bn of opportunities in the second half.

The group finished the half with net cash of $69m.

Margins in the key E&C division are now expected to be at the lower end of guidance for the year as a whole, with lower overall profitability in the second half. Revenues are expected to decline in 2020, reflecting the lower order intake in recent years.

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