WorleyParsons Tests Broker Confidence, Again

This story features WORLEY LIMITED. For more info SHARE ANALYSIS: WOR

-Broker scepticism increases
-Some see buying opportunity
-Most wary about future visibility
-Is there more downgrading to be done?

By Eva Brocklehurst

Construction manager to the resources sector, WorleyParsons ((WOR)), has confounded brokers. After sticking with full year guidance at the AGM only six weeks ago, the company has now revised FY14 guidance lower. The market was sceptical about just how, when downgrading the first half, the second half was going to provide the answers. That scepticism appears well founded.

On the FNArena database the recommendations have converged on Neutral. There's been an upgrade and two downgrades. There are now two Buy ratings and six Hold. The consensus target price is $18.49, suggesting 16.2% upside to the last share price. This target compares with $23.07 ahead of the downgrade. The dividend yield on FY14 earnings forecasts is 5.1% and 5.8% for FY15.

Deutsche Bank found the guidance downgrade disappointing but was heartened by the fact that 90% of the downgrade was from contracts that were not ramping up as planned. The Buy rating is retained. Work from these contracts should flow through in the future and the broker expects FY15 earnings growth of 34% from the mid point of the FY14 guidance. Deutsche Bank believes this is easily achievable, given FY14 earnings are negatively affected by the slow ramp up of contracts and additional costs in Canada.

The company now expects FY14 profit of $260-300m, 20% below prior consensus estimates. CIMB notes the past several years have shown the company has a seasonal skew to the second half so there is some room for optimism. Nevertheless, the broker is wary. This second, and large, downgrade will make anyone planning to buy the stock very cautious and the share price is likely to spend around six months at current levels until activity supports a renewal of confidence. There appears to be nothing structurally wrong with the business but the short duration between the downgrades is a worry, although for CIMB this is reflective of a multi-year commodity driven down cycle, which is not yet at an end.

Another downgrade and a continuation of a negative earnings trend makes Macquarie concerned about just how much visibility the company has. The greater worry is that, just six weeks out from the AGM, it has likely dented the company's credibility. Having said that, a pullback in the share price in the past has provided attractive entry points and the latest sell-off provides the opportunity for medium to longer-term investors. WorleyParsons is trading broadly in line with its closest peers, Amec and Wood, and at a discount to Jacobs. Macquarie notes WorleyParsons has a larger US business than Amec and more leverage therefore to a renaissance in North American low-cost gas. WorleyParsons is trading at 13.3 times FY14 price/earnings compared with its historical averages of 17.8 times.

The deferred projects could still drive an earnings recovery in the second half but the stock no longer deserves to trade at a premium to the market, in BA-Merrill Lynch's view. The recommendation has been downgraded to Neutral as a result. The company has exposure to global hydrocarbons which retains strong growth fundamentals but Merrills questions the ability of the business to fully capitalise on this. The positives include leverage to a lower Australian dollar, which helps earnings translation, and the fact that WorleyParsons retains significant headroom on its balance sheet even after this downgrade. Again, negative market sentiment is expected to constrain the share price upside until a sustainable earnings recovery becomes evident.

JP Morgan has seemingly gone the other way. The rating has been upgraded to Neutral from Underweight. The broker was not surprised that the negatives have conspired against company but still thinks the medium-long term prospects are intact. The share price is now better reflecting the balance of short and long-term drivers, in the broker's opinion. It's time to upgrade. Moreover, JP Morgan considers the majority of the downgrade is cyclical and the headwinds should ease next year. The stock is now trading in line with global engineering peers and in line with the broker's valuation. Hence investors are being better compensated for the near-term risks relative to the growth opportunities further down the track.

There should be no hiding of such a downgrade and Credit Suisse admits to being caught on the wrong foot. The scale of the surprise shouldn't happen, in the broker's opinion. Certainly not so suddenly. The market has always struggled with visibility in the business and now the broker thinks this must be the case for management as well. Estimates have been slashed. The broker concedes the company operates in highly attractive markets and has delivered historically. Still, until clarity is provided it's hard to invest, despite the attractive valuation/yield.

Another aspect that peeved the broker was that a project like the upstream management contract at QCLNG had a 4-year initial phase and the company has known when it would be ending. Similarly, the company said it had been caught off guard at the last downgrade but had re-sized the business accordingly. So, is a further re-size necessary? The company has said there are no underperforming contracts but Credit Suisse is left wondering, although admitting the alternative scenario is even more alarming.

Moreover, the broker does not think Canada is as plagued by subdued market conditions as many believe. WorleyParsons won big work form PetroChina recently and both Total and Shell have sanctioned major projects in the past few weeks.Then there's complaints about softness in the Middle East but Credit Suisse points to Amec's recent comments about how strong the region is. Maybe WorleyParsons is losing market share? Credit Suisse's rating has been downgraded to Neutral from Outperform and the broker wants to see cold, hard numbers before acting further.

See also, WorleyParsons Rattles Brokers on October 10 2013.
 

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