Is There Value In WorleyParsons?

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This story features WORLEY LIMITED.
For more info SHARE ANALYSIS: WOR
The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

-At issue is the balance of risk
-Lack of visibility in outlook
-MS concerned over provisions
 

By Eva Brocklehurst

WorleyParsons ((WOR)) is facing a difficult environment, attempting to balance long-term sustainability with the need to reduce costs. The company has announced $125m in non-recurring charges to be taken in the second half, consisting of redundancies and onerous lease charges as well as an increase in general project provisions.

The problem in Citi's view is investor uncertainty around the pace and extent of the cyclical correction in oil & gas exploration, which outweighs considerations regarding what the share price is already discounting. The broker acknowledges this attitude is likely to continue but, assuming a 50% fall to trough from peak, the trough valuation does not look that demanding. Admittedly, lower head count is a precursor to lower revenue and the broker suspects costs savings could be overwhelmed by ongoing pressure on industry capital expenditure.

Accurately determining the impact and timing of the oil & gas sector's capex downturn is dangerous, Citi admits. The broker is working on the assumption that growth in FY16 and FY17 will reflect the material change in industry economics in core markets. The broker doubts that either the non oil & gas business or the company's bias towards brownfield and more maintenance style activity will be sufficient to sustain revenue at the levels of recent years.

Ultimately, the broker contends, the issue for the share price comes down to the balance of risk. The large fall in the share price and negative trend for earnings should, at some stage, be a positive influence on the risk/reward ratio, in Citi's view.

UBS notes head count is expected to be lowered by 2,000 or more. The net result is a 12% reduction in the broker's profit forecasts for FY15. Forecasts for FY16 and FY17 have been lowered 6.6% and 4.4% respectively, as have dividend estimates. The broker considers the company well managed and with a strong track record, but the lack of visibility over earnings in the face of a "lower for longer" oil price means increased risk around potential project deferrals and cancellations.

Management has guided to second half earnings to be around 50% of the first half, which implies FY15 profit of $157m. Deutsche Bank reduces earnings estimates for FY16 and FY17 by 6.0% to reflect weaker conditions, but assumes margins remain broadly flat between FY15 and FY17. The broker does not expect a cyclical recovery in oil & gas in the next 12 months, noting minimal visibility over the short term and the company's susceptibility to further earnings risk as clients constrain spending and seek price discounts.

For Credit Suisse, the main issue is how much of the reduction in revenue falls through to margins. Contract margins are under severe pressure, particularly in North America, which accounts for around 50% of revenue. The broker finds it hard to be confident in the numbers, reducing FY15 profit estimates by 30% and FY16 by 6.0%. Oil & gas capex will recover at some stage and there is no reason to believe the company cannot grow earnings again, but so much uncertainty exists at this point in the cycle that Credit Suisse prefers a Neutral outlook on the stock.

Macquarie also bewails the lack of clarity on the outlook but remains bearish on oil prices in the near term. The positive aspect for WorleyParsons is that the balance sheet is in reasonable shape and the business generates cash in a downturn. In respect of market consolidation speculation, Macquarie considers WorleyParsons would more likely acquire assets rather than be a takeover target.

Investors may question management's credibility after a similar surprise in FY15, Morgan Stanley asserts. Still the challenging market conditions and deterioration should be no surprise, given the weak oil prices and the announcements from exploration & production firms highlighting reductions in costs and capex. What is of concern to the broker is the project provisioning. There was little detail on the mix but Morgan Stanley considers provisioning for projects is unusual for a capital-light engineering firm that does not take fixed price risk. It raises doubts over the risk profile in the contract book and the broker will be looking for further detail on scope and rationale for the provisions.

FNArena's database contains two Buy ratings, four Hold and one Sell (UBS). The consensus target is $10.91, suggesting 6.2% upside to the last share price. Targets range from $8.40 (UBS) to $13.86 (Morgan Stanley). The dividend yield on FY15 and FY16 forecasts is 7.3% and 6.7% respectively.
 

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