Why recent scandals put me off investing in Petrofac Limited and BT Group plc

Scandals could destroy shareholder value at BT Group plc (LON:BT.A) and Petrofac Limited (LON:PFC).

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Oil engineering, procurement and construction firm Petrofac (LSE: PFC) has been through the mill in recent years. The flagging oil price and an ongoing investigation into the company by the Serious Fraud Office for “suspected bribery, corruption and money laundering” have hurt both the company’s reputation and investor confidence.

The shares have fallen 61% since April. But investors finally got something to cheer about today after it announced the signing of a long-term Framework Agreement (FA) for the provision of Engineering, Procurement and Construction Management with Petroleum Development Oman (PDO). 

The FA was awarded after Petrofac impressed PDO during a three-year contract. The deal is set to last 10 years with an optional five-year extension if the services provided are up to scratch. Craig Muir, the Managing Director of Engineering and Production Services at Petrofac said: “This is a landmark agreement between our two companies and marks a new level of collaboration between PDO and Petrofac. It builds upon a long-standing relationship which spans more than two decades and encompasses a significant number of projects undertaken in Oman on both a lump-sum and reimbursable basis.”

Given the relationship between the two companies, barring a disaster, it seems likely Petrofac can expect a steady flow of business for the long-term.

CEO Ayman Asfari has helmed the firm since the early 90s and owns 18.5% of it, but his position could be undermined by the SFO investigation.  Investors must also consider the ramifications of a guilty verdict beyond a fine and reputational damage. If the company’s presentation of its financial performance turns out to be inaccurate, we could see massive writedowns à la BT (LSE: BT.A).

For those with a very healthy appetite for risk, however, the company offers a 14% yield twice covered by free cash flow. In my opinion, this gargantuan payout could be a siren song, rather than a bankable dividend. I’ll be avoiding the company until the SFO announces its findings.

Accounting scandal

Back in January, BT lost nearly £8bn of its market cap in a single day after announcing a massive accounting scandal at its Italian division. It is cutting 4,000 jobs over two years in an attempt to recover from the £530m financial hit incurred as a result of the shocking revelation. 

Trading at the company is smooth, at least. Revenue, profits and free cash flow are expected to remain flat this year and industry regulator Ofcom recently announced that although BT must spin-off valuable asset Openreach, it will still remain the 100% shareholder.

This is a wonderful result, considering the potential options on the table. Openreach owns the majority of broadband and phone line infrastructure in the UK, therefore generating predictable cash flows. This decisions means BT can keep its cash cow. Suddenly its financial position, including sports rights bidding power, balance sheet and dividend safety, looks better than I expected it to.

That said, BT still carries a considerable £9bn pension deficit and heavy competition in the pay-TV and mobile markets. The company’s 3.5% yield looks safe if forecasts are accurate and the shares trade on a PE of 16. These ratings might be attractive if BT wasn’t mired in scandal, but given the current uncertainties at BT, I’ll be avoiding the shares. 

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.

Zach Coffell has no position in any shares mentioned. The Motley Fool UK owns shares of Petrofac. 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. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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