Recovery Still On Offer For Worley

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The market has pared the short-term outlook for Worley after a surprise slump in first half revenue, although recovery potential is not lost

-As oil & gas site restrictions ease revenue should rebound accordingly
-Worley remains leveraged to a reinvigorated global economy
-Cost savings benefits should be more obvious in second half
 

By Eva Brocklehurst

Oil & gas activity may have fallen away rapidly since early November, coinciding with the acceleration in coronavirus cases, but all is not lost for sector contractor Worley ((WOR)). The company has emphasised first half revenue of $4.4-4.5bn, while well below consensus expectations, was affected by deferrals, not cancellations.

Moreover, the CEO is encouraged by the amount of revenue that has been booked the second half and assesses the business is ahead of where it would ordinarily be in February.

Citi acknowledges being overly optimistic regarding the phasing of maintenance work but notes this type of activity is increasingly critical as time passes. As site restrictions ease, therefore, revenue should rebound accordingly.

Furthermore, most of the company's end markets are profitable again and maintenance cannot be indefinitely deferred. The broker expects improving revenue and expanding margins as costs are stripped out and argues for a higher multiple in line with offshore peers, retaining a Buy rating.

UBS is more cautious and downgrades to Neutral from Buy, expecting a challenging outlook for revenue for the next year. While the broker does not expect greater reductions in oil & gas capital expenditure versus the prior down cycle (-50%) it is still expected to decline by around -30%.

This is consistent with statements from several international oil companies seeking to maximise free cash flow amid is significantly lower oil price, deferring several large projects.

Credit Suisse is in a similar frame, being surprised by the announcement while noting staff numbers are down -19% year-on-year. The broker points out, at the investor briefing on sustainability in December, there was no hint of the magnitude of deterioration in business conditions.

The broker downgrades to Neutral from Outperform, noting several risks remain including oil price volatility and the rate of recovery from the impact of the pandemic on operations. There is also further clarity required on the synergies from the ECR acquisition.

Previously, Ord Minnett had a Lighten rating based on a view that the stock price did not reflect the weak business conditions. As a result of the update, while the short-term outlook remains muddy, the valuation has improved and the broker upgrades to Hold.

Uncertainties

Macquarie envisages recovery over the medium term, noting strong cash flow is a redeeming feature of the business. Stabilisation of staff numbers remains the key metric as well as the ability to capture a meaningful share of the opportunities in renewables.

In addition, the company expects to announce strategically important projects in carbon capture and hydrogen shortly. There is a risk the impact of the pandemic persists in the second half and Citi, too, awaits confirmation of improving personnel numbers and second half sales.

UBS acknowledges the company expects higher earnings in the second half amid benefits of cost savings and ECR synergies but suspects confidence in the delivery of cost savings will be low following the surprising downgrade to the first half.

Admittedly, investors with longer horizons may prefer to look to beyond FY23 and the leverage Worley offers to a reinvigorated global economy with increased demand for energy. While Worley continues to move towards sustainability and the global energy transition revenue from this segment, the broker points out, currently represents only 10% of overall revenue, ex LNG.

Morgan Stanley assesses Worley is well-positioned for the energy transition but does not underestimate the importance of the shorter-term outlook for earnings as the latest downgrade highlights the challenges of both the pandemic in terms of access to sites and lower oil & gas prices.

Margins

Morgan Stanley was expecting a weaker outcome for the first half but finds few signs that cost reductions are protecting the business from lower activity. Guidance represents a -26% revenue decline from the prior corresponding first half, and margins also seem weaker.

The broker agrees consensus is likely to re-base estimates, although anticipates FY22 will provide some revenue growth and cost reductions, with margins returning to the mid 6% level.

Macquarie reminds the market that there is a tendency to underestimate the operating leverage of cyclical stocks, noting the issue in the first half centred on margins, as cost savings were unable to offset the extent of revenue declines.

While this reflected fixed cost leverage there are also timing issues and the benefits of cost savings should be more obvious in the second half. Macquarie also assumes a path back to pre-pandemic earnings margins of more than 6% but suspects this will not be achieved until FY23.

FNArena's database has two Buy ratings and four Hold. The consensus target is $10.78, signalling 6.9% upside to the last share price. Targets range from $9.20 (Credit Suisse) to $12.10 (Citi).

See also, Sustainability Opportunity Beckons Worley on December 4, 2020.

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