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Petrofac - orders building, E&C losses continue

Petrofac's trading update revealed a 65% increase in the order backlog to $5.6bn over the first six months of the year.

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Petrofac's trading update revealed a 65% increase in the order backlog to $5.6bn over the first six months of the year. Bidding activity in Engineering & Consulting (E and C) is particularly strong with a further $14bn of contracts up for award in 2023.

Asset Solutions and Integrated Energy Solutions (IES) are both trading in line with expectations, with the former expected to deliver first-half revenue of $0.7bn, and an operating margin of 2 to 3%. Net production at IES for the period is anticipated to be 0.6m barrels of oil, unchanged from the same period last year.

E and C revenues are likely to be around £0.5bn with operating losses in the region of $0.1bn, including $50m of write-downs relating to legacy contracts.

Petrofac expects free cash flow to be negative in the first half, but to be broadly neutral over the full year.

The shares were up 1.8% in early trading.

View the latest Petrofac share price and how to deal

Our view

Petrofac designs, builds, manages and maintains oil, gas, refining, petrochemicals and renewable energy infrastructure. It's making solid progress in rebuilding its order book and sales pipeline. And further significant opportunities are available, with Petrofac highlighting $73bn of contracts up for grabs by the end of 2024.

A €13bn framework awarded by TenneT demonstrates that the company can win big tenders in energy transition infrastructure, but note that the spoils of that deal are being shared with Hitachi Energy. The key will be not just conversion, but also securing strong commercial terms. Pricing discipline is essential, to avoid a race to the bottom.

Whilst the oil field services industry is showing tentative signs of recovery, oil prices have come down from the heights of 2022, and the outlook for crude remains murky in the face of a challenging global economy. That's something the new boss Tareq Kawash is going to have to face head-on. Lower oil prices would also directly impact earnings at Integrated Energy Services, last year's best-performing division in terms of profit growth.

We also see rising debt as a key concern to call out. Petrofac's not expecting any material cash call on debt till 2024. But its ability to fund operations and meet its lenders' financial criteria depends on cash collections related to legacy contracts. Any material delays could threaten Petrofac's ability to bid for and take on new work. We're therefore sceptical about an imminent return to dividend payouts, and as ever no dividends can be assured.

Petrofac's demonstrated that it has the expertise to help clients roll out much-needed energy infrastructure. And whilst it's becoming less reliant on the problem projects of the past, they're still dragging down financial performance. Tareq Kawash has set out his vision of building a more diversified business leveraging its technical expertise to take advantage of opportunities in the energy transition.

In the medium term, Petrofac's targeting $4-$5bn of sales annually and a return to industry-leading margins. If this can be achieved, shareholders are likely to be rewarded, but getting there won't be easy and nothing is guaranteed. His first job is to steady the ship and deliver financial stability. Until such time, investors should expect some volatility.

Environmental, social and governance (ESG) risk

Environmental concerns are the primary driver of ESG risk for oil and gas producers, with carbon emissions and waste disposal being the main issues. Health and safety, community relations and ethical governance are also contributors to ESG risk.

According to Sustainalytics, Petrofac's management of ESG risks is average. It has a strong environmental policy and has appointed a management committee for ESG issues, but its ESG reporting doesn't align with leading reporting standards. Its whistle-blower programme is strong, reflecting changes to the governance regime following an investigation by the Serious Fraud Office. However, this is now the subject of a lawsuit by a group of investors. Although ESG targets have been included in executive performance reviews, they're not clearly outlined in the remuneration policy.

Petrofac key facts

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.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. 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 disclosure for more information.

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Written by
Derren Nathan
Derren Nathan
Head of Equity Research

Derren leads our Equity Research team with more than 15 years of experience in his field. Thriving in a passionate environment, Derren finds motivation in intellectual challenges and exploring diverse ideas within his writing.

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Article history
Published: 27th June 2023