I’m shunning this turnaround stock to buy Royal Dutch Shell plc

Royal Dutch Shell plc (LON: RDSB) is in full-blooded turnaround mode and is a much better bet than its industry peer, says Harvey Jones.

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Oil services company Petrofac (LSE: PFC) published its half-year results to 30 June this morning in what has been a turbulent time for the stricken company. When news broke in May that it had suspended its chief operating officer in response to the Serious Fraud Office investigation, investors fled on the tacit admission that management had a case to answer.

Fac sheet

The SFO investigation could take two years and with potential fines totalling £800m, it will cast long shadows over the share price. It certainly cast a different light on today’s update, making a mockery of group chief executive Ayman Asfari’s claim that: “Petrofac has made a positive start to the year, delivering solid first-half results that reflect good project execution and lower revenues.” Talk about putting a gloss on things.

Having said that, today’s underwhelming figures look reasonably positive given the group’s troubles, and the stock is flat in early trading. That is despite a near 20% year-on-year dip in revenues from $3.89bn to $3.13bn, and an 11% drop in EBITDA earnings from $362m to $323m. Business performance net profit was down 4% to $158m. Markets were primed for worse.

Bid wins

Petrofac has enjoyed one boost lately, having secured $2.7bn of new orders, notably in Oman, which suggests it can still win the business despite the corruption overhang. Asfari sees this as evidence of the group’s continued competitiveness in challenging markets and says tendering activity remains high, positioning the group well for the second half of 2017.

Petrofac has a backlog of $12.5bn worth of orders, while the firm is also working to strengthen its balance sheet and reduce its $1bn net debt pile. The interim dividend has been cut, or “rebased”, from 22 cents per share in 2016 to 12.70 cents. The firm is also reducing costs, cutting capital investment and divesting non-core assets.

Surer of Shell

Petrofac is no longer a falling knife but given the ongoing fraud investigation I don’t think it is a tempting turnaround stock yet. City analysts are forecasting 4% earnings per share (EPS) growth in 2017, but this is followed by a sharp 19% drop the year after. Long-term investors emboldened by recent contract wins may be tempted by the lowly valuation of just 5.6 times earnings, and the forecast yield of 9.6% for 2018 (although you cannot rely on that), but fraud scandals often go wider and deeper than people expect. 

Royal Dutch Shell (LSE: RDSB) looks a better way to play any oil price rebound to me. It has worked hard to de-risk its balance sheet and equip itself to survive $50 crude, covering its first quarter dividend payout with cash from operations at an average Brent price of just under $55. 

Royal returns

In May, Shell’s profit after tax leapt more than sevenfold from $484m to $3.5bn. Any rise in the oil price would be a massive sentiment booster, but stagnation would hardly be a disaster if you still get that forecast 6.6% yield. Shell’s EPS are forecast to rise a whopping 189% across full-year 2017 and 15% in 2018, offering further comfort. It is on a forecast valuation of 16.5 times earnings, which is hardly demanding. I would pick Shell over Petrofac without hesitation.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Harvey Jones does not own the shares of any company mentioned in this article. The Motley Fool UK owns shares of Petrofac. The Motley Fool UK has recommended Royal Dutch Shell B. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. 

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