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Petrofac - 1.5bn USD of contracts cancelled

Nicholas Hyett, Equity Analyst | 16 April 2020 | A A A
Petrofac - 1.5bn USD of contracts cancelled

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Petrofac Ord USD0.02

Sell: 221.30 | Buy: 223.40 | Change 22.10 (10.97%)
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Petrofac has received notice that two of its contracts with the Abu Dhabi National Oil Company (ADNOC) have been cancelled. The two contracts were awarded in February and worth $1.5bn.

Petrofac is looking at "alternative options to deliver this project in a way that supports their [ADNOC's] strategic objectives within the current challenging environment". Work is progressing on the remaining $7bn order book.

The shares fell 13.7% in early trading.

View the latest Petrofac share price and how to deal

Our view

Petrofac had reported a relatively positive first quarter, with the order book delivering meaningful growth. The cancellations of contracts in Abu Dhabi has undone that good work, taking a huge chunk out of the order book, and marks the start of what will be tough times.

The dramatic decline in the oil price is set to reduce capital spending across the oil & gas industry this year, and that will have knock on effects for Petrofac.

So far day-to-day disruption seems to be minimal, and Petrofac's servicing activities are the kind of essential work that, by and large, needs to continue throughout any lockdown. A bias towards lower cost Middle Eastern and North African oil markets should provide some shelter too. But we still think new contracts will be few and far between.

It doesn't help that the group's not going into the current crisis in the best of shape. It's been under investigation by the Serious Fraud Office (SFO) for some time, and we suspect that has contributed to an extended decline in the size of the order book - which fell 22.9% last year. Management comments at the half year suggested that's particularly true in the key Saudi Arabian and Iraqi markets.

With revenue likely to struggle, attention has turned to costs and cash preservation. The groups' already proven adept at trimming costs when times are tough, but the most recent round of cost savings are far more brutal. Most staff have seen their pay cut, and 1 in 5 jobs have gone altogether. Even then the group's looking to cut capital expenditure and slash the dividend to keep cash in the business.

The good news is, for now at least, the group has access to significant cash. It finished last year with a modest net cash position, and along with existing loan facilities means it can weather a short period of inactivity. However, if the SFO should find Petrofac at fault then it could face a significant cash fine which would change the situation dramatically - although we note no charges have been brought against either the company or any current employees.

Against this backdrop the decision to cut the dividend is probably the right one. If the coronavirus and oil price disruption proves short lived there's always scope for a bumper return later in the year. However, recent history suggests to us that investors should take a cautious view of any subsequent recovery.

The oil & gas sector is likely to emerge with less cash and more debt, potentially restricting capital spending for some time. Given Petrofac has struggled to win business in a time of plenty, more straightened financial conditions are unlikely to treat it well.

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Coronavirus Update - 06/04/20

Petrofac has announced a series of cost saving measures in response to the coronavirus outbreak. Collectively they are expected to save $100m in operating costs in 2020 and $200m in 2021, while the group is also cutting capital expenditure by 40% and suspending the 2019 final dividend as it looks to preserve cash.

The company secured $2bn of new orders in the first quarter, with the order book rising to $8.2bn ($7.4bn at the end of 2019).

Activity continues across most of the group's Engineering & Construction sites, although progress has been disrupted by supply chain issues, travel restrictions and government lockdowns in India and Iraq. Engineering & Production Services continues to operate across all regions although social distancing and travel restrictions ae having a modest effect on activity.

Among the actions being taken to trim operating costs Petrofac is cutting salaries and allowances for most employees by 10-15%, reducing personnel by around 20% and reducing non-staff cost by up to 25%.

At the beginning of April Petrofac had access to $1.1bn in cash and borrowing facilities with debt maturities of $275m in the next two months. To preserve cash in the short term Petrofac has cut planned capital expenditure in 2020 by 40% ($60m) and suspended the final dividend ($85m). The Board "will review the resumption and payment of dividends when the full impact of COVID-19 and low oil prices is known".

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