The last month has been hugely challenging for Petrofac (LSE: PFC). It is being investigated by the Serious Fraud Office (SFO), which has caused its share price to slump to 370p from over 800p less than a month ago.
Clearly, further share price falls cannot be ruled out. In the short run, Petrofac appears to be a high-risk stock to own, since the outcome of the SFO’s investigation is a known unknown. However, in the long run the company could still have a relatively bright future for the following two reasons.
Oil price potential
While Petrofac is not an oil producer, the focus of its business is on support services within the Oil & Gas industry. Therefore, its performance as a business is closely linked to the oil price, since this determines profitability within the oil production industry. Higher profits generally mean greater investment-related activity, which is good news for companies such as Petrofac.
While the oil price has experienced a difficult period in recent years, its long-term outlook could be relatively bright. The supply surplus which has been a feature of the market in recent years could now have an opportunity to be eradicated, since OPEC has implemented a production cut over the last six months. Encouragingly for the oil price, this has been extended for a further nine months, which should provide an opportunity for demand to catch up to supply.
Certainly, it will take time for this to take place. However, demand from emerging economies such as China and India is set to grow in future years. Although there will almost inevitably be a gradual shift towards cleaner forms of energy, oil is likely to remain a major part of the energy mix over the long run. For example, car ownership is expected to increase significantly in China and demand for oil could therefore increase. This would be likely to have a positive impact on the oil price and, potentially, on Petrofac’s financial performance.
Margin of safety
As mentioned, the Petrofac share price could come under further pressure in the short run. However, its long-term appeal appears to be high given its current valuation. It now trades on a price-to-earnings (P/E) ratio of around five using last year’s earnings figure.
Of course, there is scope for profitability to come under pressure in the near term, but the market appears to have priced this in. Similarly, a dividend yield of over 14% may be unrealistic, but it nevertheless shows that investors may be expecting significantly negative news flow in future which may or may not present itself. This could provide a buying opportunity for less risk-averse, long-term investors.
Looking ahead
While Petrofac appears to be a high-risk investment, it could also offer high returns. In the short run, its shares could be volatile and may fall further. However, due to the potential for a rising oil price and the company’s wide margin of safety, it could prove to be a highly rewarding stock for the long run.
