Australia | May 20 2013
-Earnings downgrade hits hard
-Company is diverse and resilient
-Hydrocarbons key to growth
-And there's a dividend while waiting
By Eva Brocklehurst
Diversified resources infrastructure provider, WorleyParsons ((WOR)), hit the market with an earnings downgrade and investors took out their frustrations on the share price. Is this justified? Brokers are of mixed views on that. Near term, as is the case for many that are providing services to build mine infrastructure, the talk is all about cut-backs to scope and project delays. Longer term? The geographic spread and exposure to the more buoyant hydrocarbons sector means WorleyParsons should be well placed, when things improve.
Cost cutting by WorleyParsons' clients in Western Australia contributed a large part to the downgrade, as well as softening conditions in the Canadian oil sands market. The oil sands company Cord was a key to first half strength but construction activity has softened and it appears this business will not deliver the level of growth previously expected. One of the negative aspects of the Canadian oil sands economics is that Canadian oil sands prices are at a discount to West Texas Intermediate. Greenfield projects are harder to justify. What may deliver a benefit for WorleyParsons, in Macquarie's view, is the Keystone pipeline approval in the next six months. This could deliver improved supply of Canadian oil sands to the US Gulf coast and, in turn, reduce the price discount.
The growth for FY13 is gone, nonetheless, largely courtesy of Western Australia. This is what the market has focused on. The profit guidance of $320-340 million for FY13 compares to FY12's underlying earnings of $345.6m. The quantum of the impact of the downturn was larger than JP Morgan expected and this broker does not expect conditions to get better soon. The company's Improve division – brownfields operations and maintenance – is likely to provide the growth and visibility on earnings down the track but this business does have lower margins compared the execution phase businesses. JP Morgan is just not convinced that all the negatives have been factored in and remains the most cautious of the brokers on the FNArena database, with a Sell rating (sector relative).
Hydrocarbons is the company's strongest division, representing 70% of earnings, and here growth is expected. The outlook for US downstream activity in refining and petroleum is improving, instigated by cheap US gas. Macquarie notes 45% of WorleyParsons' revenue now comes from North America but the exposure to hydrocarbons is global. WorleyParsons has 33% of segment revenue from Canada, 18% from the US/Caribbean, 13% from Europe and 19% from Australia. Credit Suisse views the company as well placed to win a fair share of new projects in deep water, sub-sea, arctic and unconventional oil and gas where WorleyParsons has a competitive advantage. Management flagged the fact that some key customers in the Middle East and the US were actually intent on increasing capex spending next year in this regard.
Macquarie calls it the "second half club", which WorleyParsons has now joined. The second half is not meeting expectations for a number of companies and they are being forced to issue profit warnings. Macquarie had flagged WorleyParsons' potential to be initiated into the club, but thought the strength in hydrocarbons and diversity of earnings streams would get the company over the line. It seems the Western Australian infrastructure and environment division delivered the biggest blow with resource project deferrals, including Woodside Petroleum's ((WPL)) Browse Basin decision. There is also WA restructuring costs and onerous lease provisions in the second half which are contributing to the deterioration. There was also reduced spending in South Africa, the US and Canada.
Macquarie finds WorleyParsons is now trading at a 17% discount to global peers on a FY13 price/earnings ratio. It is trading at a slight premium to closest peers Amec and Wood but at a discount to Jacob. In spite of this, WorleyParsons is considered one of the few that can deliver sustainable earnings growth over the next few years. The key word is "confidence". Here, guidance at the FY13 results in August will be critical for brokers. UBS has lowered expectations for FY13, FY14 and FY15 earnings by 10%, 23% and 25% respectively, assuming an ongoing deterioration in the minerals/metals and infrastructure & environment divisions. Yet, medium-to longer-term the outlook is robust on the back of favourable oil and gas fundamentals.
The earnings downgrade relates to the underperformance of divisions which account, collectively, for 14% of revenue and on this basis Credit Suisse believes the market reaction was over the top. The stock on Credit Suisse's estimates is trading on a forward price/earnings of 12.1x. To arrive at a discounted cash flow valuation in line with the current share price the assumption must be made that earnings margins stabilise below trough levels. For Credit Suisse this is overly bearish, given the company's dominant market position, solid execution and acquisition track record.
CIMB had formed a view, just before the latest guidance was issued, that WorleyParsons was significantly undervalued given the global footprint and diversity of its business. The broker is not eating humble pie, other than to cut earnings forecasts for FY13 in line with guidance, observing that, within the Western Australian businesses it was the bottom-line leverage of one poor performer, representing just 4% of revenue, that was underestimated.
CIMB admits the market will want proof that the company can grow but, if the Cord problems are mostly about timing and Western Australia is restructured appropriately, then this could be end of the downgrade. Moreover, with a 5% yield in FY14 and a payout ratio under 70%, the broker believes investors will be at lest well paid while they wait.
On the FNArena database the consensus dividend yield for FY13 earnings is 4.6% and for FY14 earnings 4.9%. The consensus target price is $22.62, signalling 14.7% upside to the last share price. There are four Buy ratings on the stock, three Hold and one Sell.
WOR has pursued a strategy of globalisation for its metals, mining & chemicals and infrastructure & environment businesses. In FY10, Australia accounted for 59% and 56% of respective revenue. In FY13, Macquarie estimates Australia will account for closer to 40% of each. Latin America and Asia/China have driven much of the diversification in the former while Latin America and Africa have driven the latter.
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