Shareholders in FTSE 250 energy services specialist Wood Group (LSE: WG.) have had a tough ride over the last couple of years. Hopes were high in July that a 230p bid from Dubai-based rival Sidara might provide a profitable exit from a difficult turnaround.
But the bid fell through on 5 August when Sidara decided not to make a firm offer, blaming “geopolitical risks and financial market uncertainty”.
This situation has left chief executive Ken Gilmartin under renewed pressure. However, Wood’s latest half-year results suggest to me that a genuine recovery’s underway. If Gilmartin can deliver on his targets, my analysis suggests the stock could be too cheap at current levels.
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Performance is improving
There’s an old stock market saying that turnover is vanity, profit is sanity and cash flow is reality. What this means is that it’s easy to boost sales (turnover) if you aren’t too worried about making a profit.
Gilmartin’s wisely resisting the temptation to boost revenue with risky, low-margin work. Instead, his focus is on improving profit margins and cash generation. This should make Wood Group a better-quality business.
The company’s half-year results suggest to me that he’s making progress. Although revenue fell 4.8% to $2,844m compared to the first half of 2023, adjusted operating profit for the half year rose 14.2% to $102m. Cash flow from operations also rose 29.3% to $51m on an adjusted basis.
Wood Group hasn’t yet reached a point where it’s generating surplus cash to fund debt repayments or dividends. But it’s getting closer.
Gilmartin left his financial targets for 2024 and 2025 unchanged at the half-year mark and expects to report “significant free cash flow” in 2025.
Why it could be too cheap
Broker forecasts I’ve seen suggest Wood Group could generate $136m of surplus cash in 2025. Comparing this estimate to the company’s £925m market-cap gives me a forecast free cash flow yield of 11%.
As a rule of thumb, I’d consider anything above 6% to be potentially cheap. But there’s a catch. Wood Group has more than $1bn of net debt. That’s a bit too high for my liking. If the company hits its free cash flow targets, I expect a lot of this cash to be used to repay debt. A return to dividend payments could take longer.
However, the firm’s debt problems are no secret. They’re one reason why the stock’s trading more than 40% below its book value, which I estimate at 245p per share.
If Gilmartin can rebuild Wood’s profits and cut debt, I think the share price could bounce back towards that 245p level. Based on a recent price of 135p, this could turn 55p invested today into 100p.
What I’d do now
Wood Group still faces turnaround challenges, and its order book could shrink if oil and gas markets slow. Debt remains a risk, for now at least.
The company also has nearly $300m of historic liabilities relating to asbestos compensation payouts. These are expected to continue to at least 2050.
Even so, I think most of the risks are now reflected in the share price. If Wood Group’s recovery continues as expected, I reckon the shares could perform well from current levels.
