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Petrofac - some progress, but orders still few and far between

Nicholas Hyett, Equity Analyst | 28 June 2021 | A A A
Petrofac - some progress, but orders still few and far between

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Petrofac Ord USD0.02

Sell: 123.00 | Buy: 123.80 | Change 0.50 (0.41%)
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In a brief update ahead of half year results Petrofac said that overall trading was in line with management expectations.

The Engineering & Production Services (EPS) business reported growth in both revenue and margins and ''robust order intak''. However, this was offset by continued challenges in Engineering & Construction (E&C), with the overall backlog falling by $1bn to $4bn.

The shares were broadly unmoved following the announcement.

View the latest Petrofac share price and how to deal

Our view

2020 was a pretty bleak year for Petrofac. The collapse in the oil price meant many projects were delayed or cancelled, leaving revenues lower, pandemic related costs higher, and some contracts were pushed into loss making territory. However, the exceptional nature of 2020 means profits this year need to be taken with a healthy pinch of salt - they're not a useful guide to what will happen in 2021 or beyond.

What really counts is Petrofac's ability to win new business once the sector starts to re-open.

Back at full year results the group was bidding on $54bn of projects due for award before the end of 2022. Having won $0.5bn in the last six months the group now has $48bn of new business due for award by the end of 2022. That suggests a win rate of not more than 8.3% - which if repeated over the next 18 months would actually see the order book grow slightly (although the true win rate is probably slightly lower).

The challenge the group faces when winning new business are twofold. Firstly oil & gas business have trimmed capital expenditure plans following the oil crash last year, and secondly the group is still wrestling with an ongoing SFO investigation. A former Petrofac employee pled guilty to offences under the Bribery Act in relation to contracts awarded to Petrofac, and the investigation has now extended into the UAE as well. While neither Petrofac nor any current employees have been charged with any offences, the result is that several key markets including the UAE and Saudi Arabia are currently closed to it.

We worry that the pressing need to win business could lead to overly aggressive bids for what contracts are available, boosting revenues at the expense of margins and profits. That's an age-old problem in the construction sector and one Petrofac needs to avoid.

The goods news is that putting new business to one side the company seems to be making some real progress. Cost control in its core engineering businesses means the group hopes to modestly improve margins in 2021. Recent wins in renewables and low carbon energy are also a positive, albeit a small part of the business at present. If recently installed CEO Sami Iskander can deliver both new business and margin improvements, 2020 will prove to be the low point in a hair-raising rollercoaster for shareholders. The upward slope could be sharp.

Unfortunately, the balance sheet is not ideally positioned if things don't go to plan. Having run a net cash position last year the group is back with a modest net debt position - despite cancelling the dividend and making disposals. Available liquidity (through both cash and undrawn debt facilities) is still substantial, at $0.9bn.

The company's future depends on a turnaround in fortunes for the oil sector (over which it has no control) and we saw in 2020 that the ongoing SFO investigation has the potential to cause upsets. For now the all-important number at Petrofac is the order book and we need to wait and see a path to sustained growth there until we're more enthusiastic about the future. Even the most efficient business can't make a profit without projects to work on.

Petrofac key facts

  • Price/Earnings ratio: 10.5
  • 10 year average Price/Earnings ratio: 9.1
  • Prospective dividend yield (next 12 months): 2.4%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Half Year Trading Update

E&C revenues are expected to come in at around $1bn, reflecting lower levels of activity and the reduction in scope of some projects. Lower tax and project support costs are expected to mitigate the revenue decline, with net margins expected to be between 2 and 2.5%. The division has secured new contracts worth $0.1bn in the half and expects clients to remain cautious in the near term. The division's backlog shrank from $3.3bn to $2.3bn.

EPS revenues are expected to be $0.5bn in the first half, with net margins of 5.25%-5.75%. The division won $0.4bn of new business in the half - across the North Sea, Iraq and Oman. The division has also made progress in new energy categories and secured 10 contracts covering carbon capture & storage, blue & green hydrogen and waste-to-fuels in the first half of the year. The division's backlog remained unchanged at $1.7bn.

Integrated Energy Solutions (IED) reported net production of 0.2m barrels in the half, down from 0.5m a year ago following asset sales and an unplanned outage at one field. The division will benefit from a higher oil price and lower depreciation and finance costs.

Petrofac finished the half with net debt of $290m (December 2020: $116m) as a favourable working capital position unwound.

Find out more about Petrofac shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.