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Petrofac - update suggests challenging financial position

Petrofac’s negotiations with lenders could see significant dilution for shareholders - Head of Equity Research, Derren Nathan, shares the latest.
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On Friday, Petrofac provided an update on its strategic and financial review. Discussions are ongoing to restructure its debt which would result in converting a significant part of its borrowings into shares. Net debt was $584mn at the last count and the company has previously guided that this increased modestly in the second half of last year.

Negotiations to dispose of non-core parts of the business continue. The Group remains focussed on overcoming challenges in securing financial guarantees to support its $8bn business backlog.

The shares closed down 20.5% on the day of the announcement.

Our view

Markets have been disappointed so far by Petrofac’s efforts to restructure the business and shore up the balance sheet. Having to issue shares to the company’s lenders is a distinct possibility. Investors are rightly concerned that their ownership of the company may be significantly diluted. And for now there is no guarantee further funding will be secured.

Petrofac designs, builds, manages and maintains oil, gas, refining, petrochemicals and renewable energy infrastructure. It's been making solid progress in rebuilding its order book and sales pipeline. But what investors really want to see is a return to profits and cashflows, and progress on that front has so far been disappointing. That’s heaped pressure on Petrofac's balance sheet. And there's still some work to do to assure the company's future.

Talks are also under way to sell off parts of the business. Until clarity emerges on the shape of the business, investor sentiment is likely to remain negative. That’s reflected in a valuation sitting at close to an all time low. Whilst this may appear to be a tempting entry point for investors in the company’s shares, we warn that it comes with an elevated level of risk. Further disappointments on this front would likely cast a bigger shadow over the company's future and therefore sentiment towards the shares.

Should a solution be found, the key will be not just winning new business, but also securing strong commercial terms. Pricing discipline is essential, to avoid a race to the bottom. We also see headcount as a key metric to get right. Petrofac is a relative minnow in the energy equipment and services space. That gives it less bandwidth to invest in hiring skilled engineers in anticipation of new business. Over-hire and the bottom line gets punished. Hold back and there could be problems delivering projects.

Volatile oil and gas prices make this equation harder to balance, as customers evaluate whether or not to embark on new projects. Fortunately, recent success in securing work in the renewable energy space shows the business doesn't have all its eggs in one basket.

Petrofac has previously set out its stall of achieving $4-$5bn of sales annually and a returning to industry-leading margins over the medium term. This is an ambitious target with some analysts even forecasting a return to dividend payments. But given the pressure on cash flows we don't currently see any scope for handouts to shareholders.

In the immediate future, we caution that efforts to shore up the company's finances are likely to be the key driver of Petrofac's valuation, and here there are no guarantees of success.

Environmental, social and governance (ESG) risk

The ESG risk to oil and gas service providers runs parallel to those impacting producers. Environmental concerns are the primary driver of ESG risk for this group, 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 strong. However, there are concerns surrounding the strength of the company's disclosures.

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. 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, based on previous day’s closing values. 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: 15th April 2024