Shares of Petrofac (LSE: PFC) are modestly lower after a trading update this morning. The oilfield services group, which is under investigation by the Serious Fraud Office (SFO), said: “We have made a positive start to the year… Our core business continues to trade in line with expectations.”
Upside potential
Bidding activity in Petrofac’s markets picked up late last year and having reported significant contract wins with Petroleum Development Oman and Kuwait Oil earlier this month, the company also said today: “The high level of tendering activity is evidence of greater confidence in our core markets and we continue to have a very good pipeline of bidding opportunities.”
The group said it expects to report an underlying net profit of between $135m and $145m for the first half of 2017 and is well-positioned for the remainder of the year.
The City consensus earnings-per-share (EPS) forecast is $1.08 (85p). The shares have been hammered down from over 900p to a current 415p, as news of the SFO investigation unfolded, which means the company now trades on a bargain-basement price-to-earnings (P/E) ratio of 4.9. Furthermore, with a consensus dividend forecast of $0.59 (46.5p), the prospective yield is over 11%. The P/E and yield indicate considerable upside potential.
Downside risk – trading
Petrofac will have to go some in the second-half to meet the 85p EPS forecast, because the underlying net profit guidance for H1 implies EPS of no more than 33p in the first-half. However, even if H2 were to be no better than H1 (something no analyst is forecasting) the P/E would still be a remarkably low 6.3 and earnings would still cover the super-high-yield dividend. Thus, in terms of trading prospects, there’s a wide margin of safety for investors at the current share price.
Downside risk – fines
The SFO investigation – which Petrofac had nothing new to say about in today’s update – is the elephant in the room. The company is under scrutiny as part of the SFO’s wider bribery, corruption and money laundering investigation into Monaco-based Unaoil, which Petrofac engaged for consultancy services primarily in Kazakhstan between 2002 and 2009.
The SFO has said it doesn’t accept the findings of a report into the matter commissioned by Petrofac and also that it doesn’t consider the company has cooperated with it. It’s necessarily guesswork but some analysts have suggested Petrofac could be vulnerable to a fine of up to $800m.
With net debt running at $1,100m and the forecast dividend costing about $200m, any substantial fine could put the dividend at risk. On the other hand, it looks like being a long-running investigation and net debt could be considerably lower by the time of any fine, if indeed Petrofac ends up receiving one.
Downside risk – rainmakers
Another consideration on the risk side is that chief executive Ayman Asfari and chief operating officer Marwan Chedi have been central to the company’s success over the last 25 years. Both men were arrested, questioned under caution by the SFO, and released without charge. However, Chedi has since resigned after being suspended by the company and while Asfari currently remains in place, circumstances may dictate he leaves. Would Petrofac’s business suffer from the loss of key rainmakers?
Weighing everything up, I’m inclined to rate the stock a ‘buy’ as a potential high-reward proposition, although clearly it doesn’t have great appeal for risk-averse investors.
