Australia | Sep 20 2012
– Moelis reiterates Sell rating on WorleyParsons
– Stock viewed as expensive relative to peers
– Premium not justified by falling margins
– Earnings visibility also poor
By Chris Shaw
The share price of WorleyParsons ((WOR)) is strongly correlated to the oil price, as Moelis notes around 68% of group revenue is derived from work in the hydrocarbon sector. The oil price doesn't directly impact on revenues, but does have an impact on activity in the sector and the level of capital investment.
Given this, Moelis struggles to justify the current earnings multiple on which WorleyParsons trades, as the broker's numbers suggest the current share price is a 27% premium relative to median multiples for peers.
As Moelis notes, consensus expectations in terms of earnings per share (EPS) growth for WorleyParsons stand at an increase of 17.5% in 2013, broadly in line with the industry median of 18.5%.
This is where the valuation issue comes in, as Moelis points out WorleyParsons is trading on a premium of about 27% to the sector's median earnings multiple for 2013 of around 11.7 times. This is despite evidence of margin erosion in recent years.
This fall in margins reflects the move by WorleyParsons away from pure design to broad based EPCM (engineering, procurement and construction management) or project management contracting. Moelis points out the broader-based work tends to attract lower margins.
As margins have come down for WorleyParsons, Moelis notes top-line growth is now similar to peers, which suggests to Moelis the current multiple premium for the stock is unjustified. This is highlighted by the fact Moelis has a price target on the stock of $24.50, well below the current share price of more than $27.00.
The other issue with WorleyParsons in the view of Moelis is earnings visibility, as the company has not disclosed its backlog of work. In general, Moelis expects capital expenditure by major oil and gas companies will continue to grow, but not at the same rate as in previous years. This implies lower earnings growth for WorleyParsons.
Assuming the current earnings multiple for WorleyParsons will consolidate under such an operating environment, Moelis retains a Sell rating on the stock given the current multiple premium to peers. The only broker in the FNArena database to agree is JP Morgan, who also rates WorleyParsons as Underweight on valuation grounds within the sector.
In total the database shows WorleyParsons is rated as Buy twice, Hold five times and Sell once, with a consensus price target of $27.83. Targets range from JP Morgan at $24.01 to Macquarie at $31.40.
The Buy argument is supported by both Macquarie and BA Merrill Lynch. Macquarie sees upside from potential margin expansion and new contract wins, while BA-ML is attracted to a balance sheet that is rapidly being de-geared.
RBS Australia's Hold rating is supported by the view there is some downside risk for the WorleyParsons share price form overly bullish consensus earnings forecasts being revised down in coming months.
Deutsche Bank also rates WorleyParsons as a Hold for reasons similar to those of Moelis in that the broker doesn't expect margins will return to the peak levels enjoyed in recent years. Citi suggests the stock is fully valued at current levels.
Having traded in a range of $19.95 to $30.09 over the past 12 months, shares in WorleyParsons as at 1.15pm today are unchanged at $27.31 in a weaker overall market. The current share price implies upside of around 2% relative to the consensus price target in the FNArena database.
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