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Why this is the only oil stock I’d ever own

Photo: Petrofac Ltd . Fair Use.

Ask a random investor to name a cyclical industry and I’m positive ‘oil & gas’ will be a very, very popular answer, particularly for those investors who’ve lost their shirt on the way down. But while there’s no escaping the cyclical nature of the industry, it must also be said that producers are rightly known for hefty dividends and many hardy contrarians that have bought when the market is frightened have made stunning profits.

For this reason, the sector isn’t one to ignore out of hand, but for more cautious investors such as myself who are focused on protecting our downside, a very appealing option may be Middle Eastern services provider Petrofac (LSE: PFC).

It has exposure to much of the upside in the industry because when times are good and producers are pumping vast amounts of oil or gas, it has plenty of work and can charge higher prices. But in times like these, when oil prices are depressed and producers cut back on new projects, they still need Petrofac’s services to maintain current projects and remain locked into contracts signed during the boom times.

This relatively stable revenue is obvious when we look at Petrofac’s accounts. Back in 2013 when crude prices were regularly above $100/bbl, Petrofac brought in $6.3bn, while last year it grossed an even higher $6.8bn as previously-signed contracts fed through. Now it must be said that earnings have fallen off the proverbial cliff as squeezed margins on new projects and a disastrous foray into a new business line took their toll.

Turnaround time?

However, we’re beginning to see a slight turnaround as the company pulls back from its ill-advised expansion into integrated energy services (IES), which involved taking a cut of profits per barrel and understandably turned sour once crude prices tanked. And margins should be picking up too. A series of asset sales from the IES division and a 25% reduction in overall headcount during the past year has allowed the company to maintain guidance of $410m net profit for fiscal 2016.

The company’s ability to remain solidly profitable even while the industry as a whole suffers is immensely attractive. And much of this is due to the fact that its core customer base is made up of Middle Eastern national oil companies. These state-owned giants need to continue pumping high volumes of oil to sustain national budgets, so are less price-sensitive than oil majors. Likewise, many of these customers’ fields are relatively old, which means plenty of high-margin maintenance contracts for Petrofac.

Furthermore, it has a relatively healthy balance sheet, unlike many large oil producers. Net debt at year-end is expected to stand at $900m, which is quite low considering the firm posted $332m in EBITDA in the first six months of the year, even including a final $100m charge related to a poorly executed North Sea project that is now complete. Low debt and sustained cash flow means the company’s 5.1% yielding dividend is incredibly safe, even during the current industry downturn. And with the shares trading at just 12 times forward earnings there’s plenty of room for upward price movement should crude prices continue to rise. All in all, a stable revenue base, healthy cashflow and very safe, high-yielding dividend make Petrofac my pick in the turbulent oil & gas sector.

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Ian Pierce has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Petrofac. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.