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Why Petrofac Limited looks like a classic contrarian opportunity

The Serious Fraud Office’s (SFO) ongoing investigation into oil and gas services provider Petrofac Ltd (LSE: PFC) looks scary and has put investor sentiment against the firm over the past month or so.

At today’s 400p or so the shares remain more than 50% lower than they were in mid-May, just before news of the SFO’s investigation broke.

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Operational business carries on

However, I reckon the firm looks like a decent candidate for a contrarian investment right now. Fear and negative sentiment surround the company and the share sell-off has been spectacular and fast, driving the valuation to a low level that looks attractive. Meanwhile, Petrofac’s operational business carries on.

On 30 May we learnt that Petrofac and its lenders have agreed to extend $1bn of the firm’s $1.2bn revolving credit facility for another year from 2 June 2020, which suggests that the bankers aren’t too worried.

Then on 8 June the company announced the securing of a long-term framework agreement with Petroleum Development Oman for the provision of engineering, procurement and construction management support services for major oil and gas projects. And on 13 June Petrofac revealed it has agreed a five-year relationship with Kuwait Oil Company for the provision of specialist technical training and competency development services.

It seems that both lenders and customers expect Petrofac to trade beyond the outcome of the SFO’s investigation and remain happy to continue business with the firm for years to come.

Sentiment pummels the valuation

Meanwhile, the depressed level of the share price throws up a forward price-to-earnings rating just below six and the forward dividend yield runs at almost 11, which at first glance seems to build in a lot of fat to insulate investors from any penalties enforced after the SFO’s investigation.

Yet it’s worrying, isn’t it? On 12 May, the SFO said it is investigating the activities of Petrofac, its subsidiaries, and the firm’s officers, employees and agents relating to an ongoing investigation into the activities of a company that Petrofac dealt with called Unaoil.  Petrofac is putting a lot of time and resources into dealing with the SFO, so there will be costs, but we don’t know whether wrongdoing will be uncovered.

If the SFO does uncover evidence of bribery and fraud, individual directors and employees could face conviction and financial penalties could be directed at both them and the company. But Petrofac Ltd is a legal entity in its own right and will likely continue trading even if new directors come on board to run the business. Just like the firm’s bankers and customers appear to believe, I don’t think this investigation will result in the demise of Petrofac.

Reputational damage looks limited

I’d argue that any Illegal activities are historical, so reputational damage is unlikely to affect the firm’s forward trading, especially if any guilty individuals are removed from the payroll.

That’s why I reckon Petrofac looks like a classic contrarian opportunity where we can bet against the prevailing fear and sentiment surrounding the stock in the hope and belief that a valuation re-rating could drive investor returns from here as the imbroglio recedes.

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Kevin Godbold owns shares in Petrofac Limited. 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.