But in this article I also plan to look at another stock on extremely shaky foundations, oilfield services provider Amec Foster Wheeler (LSE: AMFW).

Turnaround plan impresses

Amec rose in Thursday trading after announcing that it had swung to a £77m pre-tax profit between January-June from a loss of £446m in the corresponding 2016 half.

Celebrating the firm’s move back into the black, chief executive Jon Lewis said he was that “encouraged that the first wave of benefits of the transformation programme we began last year is now evident.” 

“Operational discipline has improved, we have more than delivered on our cost-saving targets and we have also seen the first tangible signs of sustainable growth,” he added. Amec has racked up £229m worth of asset sales since the final quarter of 2016, while the trading margin across its retained operations had improved by around 180 basis points.

The services giant had also seen the order book for its retained divisions edge 2% higher from the corresponding period last year, to £5.5bn.

… but top line remains under pressure

Still, I believe there is still plenty of risk surrounding the firm that would discourage myself at least from taking the plunge right now.

For one, the possibility of crude values remaining under the cosh as over-supply in the oil market persists is a very real threat to Amec’s revenues picture in the near-term and beyond. Indeed, the London firm said today that “challenging conditions continue in some key markets (primarily upstream oil and gas and solar).” These troubles caused revenues to crash 24% in the first six months on an underlying basis, to £2.33bn.

Meanwhile, the ongoing investigation by the Serious Fraud Office into Amec’s dealings with Una creates additional cause for concern. Indeed, the firm said in today’s half-time report that “given the stage of this matter, it is not possible to estimate reliably what effect the outcome of it may have on Amec Foster Wheeler.”

The company did assert that it does not expect the probe to derail its planned merger with John Wood Group, however. The tie-up is predicted to complete during the final quarter of 2017.

City brokers expect Amec to endure a 15% earnings slide in 2017, resulting in a forward P/E ratio of 10.5 times. While this multiple is low on paper, this is indicative of the high levels of risk the oilfield giant still carries. I for one won’t be buying any time soon.

Hanging up

Back over at BT, the City does not expect any such earnings hiccups in the immediate future however, even as subdued sales growth and the accounting scandal in Italy weighs.

The company saw revenues growing just 1% during April-June, to £5.84bn. But it was the cost of compensating Deutsche Telekom and Orange for its trouble in the Med that really made BT suffer in the first quarter — pre-tax profits tanked 42% as a result, to £418m.

While the number crunchers expect earnings to flip 12% higher in a cheap forward P/E multiple of 10.5 times, I reckon the rising trouble BT faces in the British public sector and corporate markets overseas still makes it an unappetising stock selection right now.

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The Frankie and Benny’s owner flipped higher last month after news that like-for-like sales edged down 1.8% during the 20 weeks to May 21. While far from impressive at face value, it led to chatter that the restructuring strategy is beginning to pay off but underlying sales fell by a more painful 3.9% in the 12 months to January.

But investor enthusiasm fizzled out almost immediately as fears over the structural woes facing the business resurfaced. With the bulk of The Restaurant Group’s sites being located in or around Britain’s retail parks, the company is likely to see footfall keep decreasing as tough economic conditions cause shoppers to stay at home. And the rapidly-growing internet shopping phenomenon is pulling even more potential diners away from its doors.

And increasing competition puts the recovery plan in even more  jeopardy.

Dividends diced

The Restaurant Group was forced to scythe the dividend in the year to January 2017 as earnings swung 19% lower, the company paying out 15.84p per share versus 17.4p in the previous year. And with City brokers expecting another 19% decline in the current fiscal period, another dividend reduction, to 15.4p, is currently being bandied around.

While this figure still yields a healthy 4.6%, flimsy dividend coverage of 1.4 times — some way below the widely-regarded safety benchmark of two times or above — makes me more than a tad wary that current payout projections will be met.

I reckon investors should be prepared for a much more painful payout cut than is currently predicted.

Dangerous driller

I also believe risk-averse share pickers should give Wood Group (LSE: WG) a wide berth, despite predictions of meaty near-term dividends.

The oilfield services play is expected to raise 2016’s dividend of 33.3 US cents per share to 33.4 cents in the current period, meaning it sports a market-beating 4% yield.

The number crunchers see no return to earnings growth any time soon however, and Wood Group is expected to follow last year’s 23% earnings drop with an additional 17% fall in the current period. As a consequence, dividend coverage clocks in at just 1.6 times.

Regardless of whether or not Wood Group’s proposed merger with Amec Foster Wheeler is hampered by the Serious Fraud Office probe into Unaoil — Wood has launched an internal review into its own dealings with Unaoil, while Amec has been asked to provide information to the SFO on its history — the murky state of the oil market would discourage me from spending my own investment cash right now.

Brent crude prices have receded to their lowest since November below $45 per barrel this week, and I expect the downtrend to continue as returning US shale producers keep the oil glut in business. In this environment, I would expect demand for Wood Group’s services to remain subdued, and reckon earnings are in danger of stuttering lower well beyond this year.

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Beyond the shale

The US isn’t bound by any production agreement so can carry on fracking and pumping at will, and with Donald Trump in the White House, that is exactly what it is going to do. Producers in the vast Texas Permian Basin reckon they can break even at prices as low as $30 a barrel, which makes me sceptical about investing in low-margin producers in other oil sectors and regions. I have been looking for a domestic way to play shale and I wondered whether these two companies might fight the bill.

London listed engineers Amec Foster Wheeler (LSE: AMFW) and Wood Group (LSE: WG), which agreed a £2.225bn merger last week, have both made acquisitions, giving them exposure to unconventional oil and gas markets in the US. Amec paid £1.9bn for petrochemicals engineering company Foster Wheeler in 2014, while Wood Group bought PSN in 2010 for around £600m. Wood Group has also said it would support UK shale companies if fracking is allowed here, although that could take time.

Aberdeen Anguish

The two Aberdeen-based companies have been squeezed in the wider oil sector crunch. Amec Foster Wheeler has seen its share price almost halve in the past two years. Last week’s update showed trading profits down from £374m to £318m, with like-for-like revenues down 8% to £5.44bn, as continuing weakness in the oil and gas market offset a strong performance in its solar division. Trading margins fell 110 basis points to 5.8%. 

Wood Group has also floundered, with total revenues shrinking 15.7% in 2016 to $4.93bn, while operating profits fell 22.8% in EBITDA terms. However, its £2.2bn all-share takeover gave its shares a lift, with the new entity anticipating sustainable cost synergies of at least £110m, plus diversification benefits. Let’s hope this link-up, assuming it completes, goes better than Amec’s merger with Foster Wheeler, which brought shale exposure and global diversification but saddled the company with £1bn in debt.

Power down

Amec Foster Wheeler has some diversification through its engineering and installation capabilities, while Wood Group also operates in the power plant, industrial and key energy sectors. However, oil and gas remains a tough sector to be in, and I cannot see that changing.

Although both companies now have access to US shale, their exposure simply isn’t enough to be a game-changer. Shale also has challenges, as salaries and costs are starting to climb as the boom gets back into gear, pushing up costs and cutting margins. Also, shale is likely to turn into a global revolution, with new production popping up everywhere, including a massive new basin in Mexico.

Boom or bust

If the merger goes through, the new entity will hold a combined 60% share of the North Sea oil services market, which is where their major interests lie. Their exposure to shale is relatively small. In fact, the shale boom, if it continues, is likely to inflict more harm than good on their wider energy interests.

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Monday saw a merger between Amec Foster Wheeler (LSE: AMFW) and Wood Group (LON: WG), which values the former at £2.225bn. Could it prove to be a success in the long run for investors in the merged entity?

Improving outlook

As with any merger, the number, and likelihood, of synergies is a key consideration. In the case of the Amec Foster Wheeler and Wood Group deal, it is estimated by their management teams that £110m in synergies will be delivered per year on a recurring basis. Given that the former’s pretax profit for 2017 is expected to be £190m prior to Monday’s news, it is clear that the merger is set to bring sizeable improvements to the two companies’ financial performance.

Furthermore, the two companies envisage greater revenue opportunities resulting from the merger. This could help to boost their sales at a time when the oil & gas industry looks set to continue to experience a difficult period. In addition, a size and scale advantage over sector peers could provide the merged entity with a competitive advantage, as well as superior defensive characteristics should the price of oil decline.

Valuation

The merger values Amec Foster Wheeler at a 15.3% premium to its closing price on the trading day prior to the announcement. It also represents a 28.7% premium to the prior 30 trading day volume-weighted average price of the company. This may appear generous at first glance, but it actually seems to somewhat undervalue the business. For example, it puts the company’s shares on a price-to-earnings (P/E) ratio of just 12.3. Certainly, it is the highest point at which the company has traded since October 2016, but given the long-term outlook for oil it looks as though Wood Group may have obtained a relatively good deal.

That’s especially the case since Amec Foster Wheeler was expected to return to rising profitability in 2018. This could have boosted investor sentiment and allowed it to command a higher valuation. However, at the same time, investors in the company will be able to keep their shareholding in the new business. As mentioned, it should offer even better growth potential due to size and scale advantages, as well as the potential synergies.

Sector outlook

Of course, there is no guarantee that the merger will be a success. Synergies are not always delivered as expected, and a merger inevitably creates a degree of uncertainty as integration commences. However, given the uncertain outlook for oil, creating a stronger company which may be more resilient seems to be a sound move. The combined entity may not perform significantly better than the wider industry in the short run, but may prove to be a strong buy for the long term.

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Indeed, since 2014, oil service providers have slashed costs to keep the lights on, and while this has had the desired effect, when volume returns to the market, a lower cost base should also accelerate profitability growth — great news for long-suffering investors. 

Under-appreciated 

Over the past year shares in Petrofac (LSE: PFC) have gone nowhere, just like the company’s revenue. Profits have slipped from a high of $630m in 2013 to a loss of $350m for full-year 2015. Analysts expect this trend to reverse for 2016 with a profit of $312m pencilled-in for the year, on revenue up 10% year-on-year. 

This could just be the start of Petrofac’s recovery. City earnings figures for 2017 are based on current projections from Petrofac’s backlog. If there’s a sudden uptick in demand for the company’s services, earnings growth will exceed expectations. Analysts are already forecasting earnings per share growth of 21% during 2017. Based on this earnings target the shares are trading at a forward P/E of 9.8. Such a low multiple indicates investors don’t expect much from the company. If business is better than expected, the shares could quickly re-rate higher. 

The market also seems to believe that the future is bleak for Amec Foster Wheeler (LSE: AMFW). Based on current City forecasts the shares trade at a 2018 P/E of 8.9. In the boom times, the shares traded at an average P/E of around 12.5. Just like Petrofac, shares in Amec will see a double boost of earnings growth and multiple growth if oil services demand picks up over the next few years. 

Also, after acquiring Foster Wheeler several years ago, Amec’s revenue is actually higher today than it was back in 2013, despite the downturn. With this being the case, if the group’s profit margins return to boom-time levels, profits surge to new highs. Certainly one company to keep an eye on over the next few years.

The future is bright

Shares in Hunting (LSE: HTG) have risen 93% over the past 12 months, but despite these gains, the shares could have further to run if oil services spending picks up again. 

Hunting is not expected to report a profit for the next two years. However, these City forecasts seem at odds with figures from the ground which show activity in Hunting’s primary market, the US, picking up with higher oil prices. A sustained rise in oil prices will help maintain this momentum and City forecasts in Hunting will likely be revised higher as a result. At present shares in the company are trading at a relatively undemanding price-to-book ratio of 1.1. 

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Petrofac. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

In its most recent update, for the last quarter of its financial year, the Luton-based carrier said it had delivered record passenger numbers and higher load factors during summer trading, with a significant reduction in its cost per seat over the three month period ended 30 September.

Passenger numbers over the period hit a record 22 million with a strong load factor of 93.9%. EasyJet said that its customers had benefitted from lower fares right across its network, with revenue per seat decreasing by 8.7% on a constant currency basis compared to the same period a year earlier.

Currency woes

The airline has, however,  grown capacity by 6.1% over the three month period and is continuing to deliver its strategy of enhanced long-term competitive advantage, through building leading positions at key airports in its core summer beach routes and its European City network.

EasyJet admits that strong currency fluctuations since the result of the EU referendum have had significant adverse effects on performance, with foreign exchange rate movements now expected to have a negative impact of around £90m compared to FY2015, an increase of £35m since the 23 June Brexit vote.

After hefty falls this year, the shares are trading on a cheap-looking price-to-earnings ratio of just nine, with bargain hunters perhaps looking to take a contrarian approach. But broker consensus suggests underlying earnings will shrink by 22% for fiscal 2016 and by a further 15% next year, and I would rather wait until growth starts to appear on the horizon.

Cheap, but not a bargain!

Oil and gas engineering firm Amec Foster Wheeler (LSE: AMFW) is another London-listed firm facing tough trading conditions of late. The FTSE 250 firm has been suffering a share price slump since the summer of 2014 when it reached all-time highs of 1,262p, but the shares are now changing hands at just 416p. The fortunes of oil and gas engineering firms are heavily tied to the oil price, with companies such as Amec feeling the effects of reduced capital investment in infrastructure after the recent oil price slump.

Amec is, however, taking positive steps to turn things around, such as making cost savings, and continuing its expansion into renewable energy, and this will no doubt help the company’s bottom line over the long term.

But, for now, analysts expect the firm’s profits to keep falling at least until a recovery in the oil price prompts the industry to significantly increase capital investment. In my opinion Amec’s battered shares still don’t represent good value given the gloomy outlook.

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It said it’s “on course to deliver resilient trading results for this year and next despite the continuing weakness in some of our key markets,” but the company’s shares have fallen by as much as 20%. What’s behind the fall? And should investors avoid the stock, or is this a buying opportunity for the long term?

It’s complicated

News that management needs more time to complete its strategic review seems to have unnerved investors. The company had planned a capital markets day for 15 November, but has cancelled this and rescheduled it for as far off as 21 March.

Management is promising to take “an additional £100m permanently out of our annual cost base,” and has “identified multiple long-term opportunities to offset the current headwinds” in the oil and gas industry. However, with the company having identified “a number of challenges” as well as opportunities, and these opportunities requiring “more work … to develop detailed plans on how to deliver their full potential,” the market is naturally concerned by the lack of visibility on the future shape of the business.

Similarly, while it expects to sell three assets for £100m before year-end and continues to target £500m of disposals by June 2017, management said: “We have not yet concluded our thinking on the right mix of investment and funding options which in aggregate will lead to an appropriate balance sheet and create a strong ongoing business.”

Based on a share price of 475p, Amec is trading on a forward P/E of 9.2 with a prospective dividend yield of 4.4%. However, with the task of sorting out the company clearly much more complex than chief executive Jon Lewis initially expected when he joined in April, I think this is a stock to watch for the time being.

Get set for recovery

Shares of Amec’s sector peer Hunting (LSE: HTG) also headed south today, falling by more than 5% to 480p at one point this morning.

Hunting issued a trading update and announced an equity placing, equivalent to almost 10% of the company’s current issued share capital. This has been completed, raising £70.9m at 485p a share.

Management said the revenue declines seen in previous quarters have stabilised in Q3, and that while the overall market is likely to remain subdued in the short term (particularly in offshore deepwater drilling), it’s seeing an increased level of enquiries and orders in some of its businesses. It believes these businesses “have reached the bottom … and are now preparing for a return to growth.”

The company says the placing will further strengthen its balance sheet and provide additional funds for working capital and investment to “capitalise on the localised areas of market recovery.”

Hunting is well run with highly experienced management. It did the right things as the oil price declined and I reckon it’s doing the right things now in preparing for the oil and gas industry to return to growth. The company can’t be valued on current (negative) earnings and isn’t paying a dividend. But I believe the shares are worth buying for a long-term recovery.

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Aminex’s update is positive as the company has received first payment in relation to gas produced from the Kiliwani North-1 well in Tanzania, which was supplied to the Tanzania Petroleum Development Corporation. Investors have reacted positively to the news, with Aminex’s share price up 5%.

Looking ahead, it’s expected to deliver significantly improved financial performance over the next two years. Following several years of losses, the company is forecast to move to profitability in the current year. In 2017, its pre-tax profit is due to rise from £0.3m to £4.3m, which has the potential to positively catalyse investor sentiment.

Despite Aminex’s share price having risen by 30% in the last three months, its upbeat outlook doesn’t seem to have been priced-in by the market. It trades on a forward price-to-earnings (P/E) ratio of 8.4, which indicates that there’s significant upward rerating potential.

Better bet?

However, it’s not the only cheap resources stock. Amec Foster Wheeler has a P/E ratio of 10 and is expected to return to profitable growth in the next financial year. This follows a troubled period for the business that has seen its earnings fall in each of the last two years, largely in response to the falling oil price. But with a new strategy that has improved its efficiency, Amec Foster Wheeler looks set to make a strong comeback.

Similarly, Glencore’s debt reduction strategy is likely to lead to an improved financial outlook for the diversified resources play. It has made asset disposals and has reduced costs so that it’s expected to record a rise in earnings of 57% in the next financial year. This puts it on a price-to-earnings growth (PEG) ratio of only 0.5, which like Aminex and Amec Foster Wheeler, indicates significant upward rerating potential.

However, where Glencore and Amec Foster Wheeler have a clear advantage over Aminex is with regard to their risk profiles. They’re both much larger, better diversified and have track records of profitable growth. This means they offer lower risks than Aminex and still have significant potential rewards. As such, buying Glencore or Amec Foster Wheeler is a better option for risk-averse investors.

In terms of Amec Foster Wheeler and Glencore, the former has a much stronger balance sheet and doesn’t have to make wholesale changes to its capital structure. Certainly, Glencore is making excellent progress on the debt reduction front, but there’s still a long way to go. And with Amec Foster Wheeler yielding 4% from a dividend that’s covered 2.5 times, it offers superior income prospects to Glencore’s suspended dividend. As such, Amec Foster Wheeler is a superior investment to Glencore.

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The Luxembourg-based business advised that revenues soared 15% between January and June, to £1.08bn, a result that propelled pre-tax profit 7% higher to £84.3m.

Worsening economic conditions have dented revenues at Regus more recently. Indeed, chief executive Mark Dixon commented that “global macroeconomic uncertainty has clearly increased during 2016 and we have seen softening in revenue growth in some markets on the back of that.”

Still, the company remains confident that it can deal with this, advising that “we have planned prudently for 2016 and taken specific action early in the year to improve efficiencies across the business.”

On top of this, I believe Regus’s broad reach across the globe — the firm operates in 107 countries — should insulate it from the worst that Brexit has to offer. Just 20% of sales are sourced from the UK.

I reckon Regus remains a strong long-term selection worthy of a ‘conventionally’ expensive forward P/E multiple of 21 times.

Crude calamity

Engineering play Amec Foster Wheeler (LSE: AMFW) has seen its share price explode on Tuesday, the stock last 9% higher after its own financials were released.

Amec Foster Wheeler advised that revenues climbed 7% during the first half of 2016, to £2.84bn. But this couldn’t prevent the firm swinging to a pre-tax loss of £446m from a profit of £73m during the corresponding period last year.

The business continues to be hampered by the state of the oil market, and Amec Foster Wheeler swallowed a further £440m worth of writeoffs during January-June.

And chief executive Jonathan Lewis was hardly emphatic over the segment looking ahead, commenting that “our industry continues to face very challenging conditions, with capital projects across natural resources markets being delayed and cancelled in many parts of the world.”

Amec Foster Wheeler’s P/E rating of 9.4 times no doubt makes the firm an attractive selection for many bargain hunters. But I view today’s share price strength as nothing more than a fresh selling opportunity, and expect the engineer’s bottom line to continue toiling.

Paying off

Payment processing goliath Worldpay Group (LSE: WPG) was last dealing 5% higher from Monday’s close after investors greeted the firm’s latest financials with much fanfare.

Worldpay advised that revenues jumped 10% between January and June, to £2.14bn, with the number of transactions rising 15% to 7.2bn. As a result, underlying earnings surged 19% in the period to £217.9m.

And chief executive Philip Jansen believes Worldpay has plenty left in the tank — the firm’s head advised that “while the UK’s vote to leave the EU has resulted in increased uncertainty, we do not expect it to have a material effect on Worldpay’s trading performance.”

Indeed, Worldpay retains a bullish outlook as its geographic footprint continues to expand, and the huge product investment of recent times bolsters customer numbers.

Worldpay is clearly a firm on the up, and fully deserving of its premium P/E rating of 28.7 times, in my opinion.

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While the term ‘fallen angel’ originates from the credit markets, it can also be used to describe companies that were once market darlings but have since, for whatever reason, fallen from grace.

OneSavings Bank (LSE: OSB) is one such company. Until the end of June, OneSavings was championed as one of the challenger banks that would shake up the UK’s banking industry and since the company’s IPO at the beginning of 2014, shares in the bank returned more than 100% for investors. Over the same period, pre-tax profits tripled. 

However, since Brexit investors have turned their backs on the challenger bank due to concerns about the UK’s economic outlook.

Since Brexit, shares in OneSavings are down by around 41%, a decline that seems to indicate investors believe the bank’s profits will be cut in half over the next six months.

The City doesn’t hold the same view. City analysts expect the group’s earnings per share to grow by 8% this year and a further 3% for 2017. Based on these forecasts shares in the bank are trading at a forward P/E of 5.4 and a PEG ratio of 0.7. The shares also offer a dividend yield of 4.6%.

Over-reaction to a profit warning?

Publisher ST Ives (LSE: SIV) is another fallen angel that has seen its share price cut in half over the past six months. St Ives’ poor share price performance followed a profit warning from the company.

This warning came just as the group’s profits were expected to stabilise this year after nearly a decade of restructuring. Up until the warning City analysts were expecting the company to report a pre-tax profit of £37.4m for the year ending 31 July. Between 2011 and 2015 the group only reported unadjusted cumulative pre-tax profits of £49.4m. 

Nonetheless, current City figures suggest St Ives is set to report earnings per share of 17.2p for the year to 31 July 2016, indicating that the company’s shares currently trade at a forward P/E of 6.4, a rock bottom valuation that seems to discount any further disappointments.

A play on oil prices 

Amec Foster Wheeler (LSE: AMFW) is a casualty of the oil price crash. Shares in the company are down by 45% over the past 12 months. After these declines Amec’s shares are trading at a forward P/E of 8.1, City analysts expect the company’s earnings per share to fall by 19% this year before stabilising next year. Amec’s shares support a dividend yield of 5%, and the company has a relatively strong balance sheet. 

If you’re looking for a way to play a recovery in oil prices Amec could be a great pick. The company is still winning contracts in the oil sector, and two major long-term contracts in the North Sea were awarded to the group last month. Amec’s order backlog was £6.4bn at the end of March, giving just over a year’s worth of work at current run rates. Management expects revenue to register only a ‘slight’ decline for 2016 and is planning to reduce debt to £600m from the current level of £1.2bn by the end of 2017 through improved cash flow and select asset disposals. 

The post Are these three fallen angels too cheap to ignore? appeared first on The Motley Fool UK.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.