Weir Group plc falls after slashing profits forecast

Royston Wild explains why shares in Weir Group plc (LON: WEIR) could keep on tanking.

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Engineering colossus Weir Group (LSE: WEIR) has suffered a 3% fall on Tuesday after releasing a less-than-reassuring trading update.

While the pump-builder advised that “there are signs in the group’s third quarter performance that our core markets have started to improve,” investors gave little positive reaction to this news as Weir is yet to reap the fruits of these conditions.

Indeed, the company warned that “profits are expected to be slightly lower than current market expectations” in 2016 as pricing difficulties persist.

Slippery slope

Weir noted that orders at its Oil & Gas division slumped 10% year-on-year between July and September, with original equipment orders falling almost a quarter and aftermarket orders dipping 6%.

The Scottish engineer noted that in the critical North American market “volume growth was offset by sustained pricing pressure which, combined with the division’s focus on reducing inventory and maximising cash generation, restricted flow through to profits.”

But this wasn’t Weir’s only headache, the company announcing that “international markets have become increasingly challenging, with customers postponing orders and reducing activity levels.” In particular, Weir noted that competitive pressures had increased in the Middle East.

And Weir struck a cautious tone looking ahead, commenting that “assuming commodity prices remain supportive, we anticipate further sequential growth for the Oil & Gas division in the fourth quarter but little improvement in the pricing environment.”

Goldman warning

Besides, hopes that raw material values will remain supportive could be a hope too far. Indeed, Brent’s capacity to move back above the $50 per barrel milestone is already under huge scrutiny as worrying supply and demand indicators keep the sector under extreme stress.

Just this week Goldman Sachs warned that Brent values are in peril of slipping back to around the low $40 bracket should OPEC members fail to initiate a much-needed output freeze, as was initially touted in September.

And this is a very possible scenario, the broker believes, Goldman Sachs commenting that “the lack of progress on implementing production quotas and the growing discord between OPEC producers suggests a declining probability of reaching a deal on November 30.”

Just the start?

It should come as little surprise that Weir’s poor update has caused investors to pile out of the door again. After all, the pump play’s 65% share surge in 2016 gives plenty of reason for today’s weakness.

And I reckon that there’s still scope for Weir’s share price to keep hurtling lower.

The company is expected to endure a 16% earnings decline in 2016, the fourth consecutive drop if realised. And this creates a P/E ratio of 25.1 times, shooting above the benchmark of 10 times widely associated with stocks that have patchy earnings outlooks.

Given the likelihood of further margin pressures at Weir — not to mention fresh order troubles should commodity prices turn lower and capex budgets across the oil industry take another hit — I reckon next year’s predicted 23% bottom-line recovery is in danger of wildly missing the mark.

I’m convinced Weir remains far, far too risky for investors right now.

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 considered so you should consider taking independent financial advice.

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

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