The Petrofac Limited (LSE: PFC) share price is up by 2% at the time of writing, as the market gives a cautious welcome to the group’s 2019 results.
Petrofac’s (modest) gain comes against a backdrop of falling share prices in the oil and gas sector. Today I want to explain why I think it’s time to buy into this turnaround story – despite the ongoing risks faced by shareholders.
Still shrinking
Petrofac doesn’t produce oil and gas – it provides engineering and services for companies that do. Since the oil market crash in 2015, the group has struggled to deliver the kind of results that once saw its shares trade at more than 1,700p. As I write, the Petrofac share price is just 367p.
The group’s revenue has fallen from nearly $8bn in 2016 to just $5.5bn in 2019. A further decline is expected this year, when analysts expect turnover to fall to about $5.1bn.
Profits have plunged, too. On an underlying basis, pre-tax profit fell from $463m to $381m in 2019. A further decline is expected for 2020.
A potential risk
One problem is that Petrofac isn’t winning as much new work as it used to. In 2019, new orders totalled $3.2bn, compared to $5bn in 2018. As a result, the group’s order backlog fell from $9.6bn to just $7.4bn.
A particular disappointment was that the company missed out on new contracts in Saudi Arabia and Iraq last year – core markets for the company, which does a lot of work in the Middle East.
Why did the firm miss out on these contracts? One likely explanation seems to be that Petrofac is under investigation by the UK’s Serious Fraud Office in relation to past contracts in both countries.
This investigation started in 2017. So far, Petrofac hasn’t been charged. Nor have any of the company’s current directors or employees. But it’s not over yet. There’s still a risk that the company could face a big fine at some point.
I suspect this is one reason why management is keeping debt levels low – Petrofac ended last year with net cash of $15m.
Too risky to touch?
You could definitely make a case for avoiding Petrofac altogether, given the risk from the SFO investigation and the company’s declining profits.
But the company is winning new work and remains profitable and cash generative. It’s also hoping to expand into the renewable market – one recent contract win will see the company supply electrical substations for the Seagreen wind farm project in the North Sea.
Offshore wind farms require some of the same engineering services as oil and gas platforms. Petrofac could be well positioned to compete in this market.
Why I’d buy
Based on today’s figures, the company is valued at less than six times 2019 operating profits. Although 2020 is expected to be another poor year, I think Petrofac shares are cheap enough to reflect the risks faced by shareholders.
The SFO case will be resolved at some point, providing greater certainty. And the chief executive owns 18.8% of the company, suggesting that his interests should be aligned with those of smaller shareholders.
In the meantime, the 8% dividend yield is covered by free cash flow and looks safe enough to me. I see the shares as a contrarian buy and would be happy to add the stock to my Stocks and Shares ISA.
