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Petrofac - no worse than expected

Nicholas Hyett, Equity Analyst | 25 February 2020 | A A A
Petrofac - no worse than expected

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Petrofac Ord USD0.02

Sell: 221.30 | Buy: 223.40 | Change 22.10 (10.97%)
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Full year revenues fell 5% in 2019 to $5.5bn, with underlying profits of $276m, down 21.8% year-on-year. Petrofac's order-book finished the year at $7.4bn, down 22.9% despite new contract wins in Algeria, Oman and the Netherlands.

The board announced a final dividend of 25.3 cents per share, taking the full year dividend to 38 cents - unchanged year-on-year.

The shares were broadly flat in early trading.

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Our view

When we open a set of Petrofac results the first thing we look for is the order book. That's continued to shrink over the last year, and while the group's done a good job of cutting costs, the shortage of new projects is starting to restrict management's room for manoeuvre.

The combination of lower revenues and a series of less profitable contracts in the core construction businesses means the squeeze on profits has been particularly painful. That trend looks set to continue into 2020.

Going forwards the sale of Petrofac's own oil & gas assets makes winning engineering contracts all the more critical. Even the best management team will struggle to grow profits if there's no work to do.

There are some glimmers of light in these results. The order book in the Engineering & Production division has returned to growth and conditions in the wider market are looking much more positive. There are $37bn of projects up for grabs in 2020, plenty of opportunity to replenish the pipeline.

However, questions remain around the group's ability to turn leads into contracts. The group landed just $1.2bn of $13bn of tenders in the second half of last year. If it maintains that level of conversion it will struggle to replenish the $4.5bn of work it already has booked in for 2020.

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 contributing factor. Management comments at the half year suggested that's particularly true in the key Saudi Arabian and Iraqi markets.

Adding to the pain for investors is the fact Petrofac would likely face a significant cash fine if the SFO were to find it at fault. That could raise questions about the sustainability of the dividend, despite the net cash position on the balance sheet, and probably explains why the prospective yield currently stands at 8.4%. Investors are worried the cash could dry up at short notice.

Putting any possible fine to one side - which is essentially out of the company's hands now anyway - the next 12 months will be crucial for Petrofac. With asset disposals largely complete the group will be relying on organic cash flow to fund dividends and investment going forwards. For that the group needs to grow its order book.

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Full Year Results

The Engineering & Construction (E&C) business saw revenues fall 5% to $4.5bn, largely due to the timing of projects. Project mix and higher rates of tax hit margins, with net profit down 18% to $278m.

Revenues in Engineering & Production Services (EPS) rose 4% to $0.9bn, driven by new contract wins. However, lower contract margins and investment in business development meant net profit fell 26% to $32m. The division completed the bolt-on of US onshore specialist W&W Energy Services during the year.

Asset sales in Integrated Energy Services (IES) saw revenue fall 31% to $195m. Excluding the effect of asset sales revenue fell 1%, reflecting lower average prices and income from partners. Net profits in the division fell 69% to £12m.

E&C order backlog fell 28.8% during the year to $5.7bn despite $2.1bn in new orders. The division struggled with the loss of awards in Saudi Arabia and Iraq during the first half. EPS backlog improved slightly year-on-year to $1.7bn.

Petrofac finished the year with net cash of $15m, down from $90m last year. That reflects a substantial decline in free cash flow as profits declined, higher working capital requirements, and a drop in divestment proceeds.

Management continue to expect a decline in group revenue next year, reflecting lower new orders in recent years. The current order book includes $4.5bn of 2020 revenue. Margins are also expected to suffer, reflecting contracts in lower margin geographies and investment in maintaining technical capabilities.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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