Edmond Jackson's Stockwatch: Petrofac

Following recent bid approaches for FTSE 250-listed Kentz Corporation, it is interesting to consider the extent to which this reflects industry exploiting cautious stockmarket ratings for support-services groups - in particular the oil and gas sector, where activity is healthy and bodes well.

A similar share is Petrofac in the FTSE 100 (UKX) index, currently trading on a modest rating of about 10 times the consensus expectation for 12-month forward earnings and offering a 3.3% yield thrice covered by earnings forecasts, after the shares have de-rated from peaks of 1,770p in 2012 and 1,740p earlier this year.

This compares with Company REFS showing an annual average price/earnings (P/E) multiple in the high teens for 2010 and 2011 and the mid teens last year. Admittedly the forward P/E for peer Wood Group is similarly 12 times - although after a near 32% rise in earnings per share (EPS) this year, Wood's EPS is expected to moderate near 11% in 2014. Its prospective yield is 1.75%, which is fine as a 'hold' although Petrofac offers better underlying momentum.

Petrofac has bounced from about 1,240p to over 1,400p around its 27 August interim results, which reversed poor sentiment as a result of delays for an Algerian gas project. Management had indicated this would hurt first-half 2013 performance and more recently the impact of a soaring US dollar on developing country finances has added to the selling.

But it appears the market became too jaundiced, as interim figures were 9% ahead of consensus estimates despite revenue down 12% to $12.8 billion (£8.2 billion) and operating profit down 27% to $295 million. Petrofac's backlog (order book) was up by a fifth to $14.8 billion at end-June, hence the shares' rebound as management indicated a stronger second half.

With the stock currently at 1,385p, there is medium-term interest in the 2014 outlook with 15% earnings growth pencilled in. The lumpy nature of contracts surrounding big projects means there are times when figures can disappoint due to delays in logistics, although the problem in Algeria had been an attack on a separate facility and the market pondering where this might lead.

But all things considered, when you look at the table for growth in profits, earnings and dividends, Petrofac is quite an enviable growth share - its price/earnings to growth (or PEG) ratio is 0.7, when a value under 1.0 is generally deemed attractive. This is based on 12-month rolling forward earnings, although management has also said it remains on track to more than double 2010 earnings by 2015.

The long-term growth case involves geographical expansion; developing the main engineering, procurement and construction activities; and developing the integrated energy services side, where management published specific 2014/15 goals last June.

There was also a useful presentation made at the interim results, to help investors appreciate where Petrofac is heading.

Progress and prospects justify my drawing attention since 675p in July 2009 and more recently at 1,350p in June 2013, noting that a buying opportunity was taking shape on fundamentals, however to bear in mind the adverse sentiment towards emerging markets as the US dollar surged. The chart now looks to have gained a couple of support points with the group backlog book affirming value.

The main short to medium-term risk is over Syria; whether an American-led attack spreads instability across the Middle East and affects shares - some perhaps more than others. Noting how Petrofac fell about 35p on Friday 30 August, when markets anticipated American action last weekend, 27% of 2012 group revenues were derived from United Arab Emirates where a $2.9 billion (net interest) project was announced for Abu Dhabi in April.

While oil prices tend to spike over Middle Eastern tension, caution about the medium-term implications for global demand tends to mean oil-related shares can be indifferent or even drop with markets generally.

A company-specific risk is second-half progress not meeting the guidance management has just maintained, two months into the period. However, downside from this ought to be limited considering the bullish 2014 prospect. Both the Algeria and Abu Dhabi projects should bolster group numbers next year, also considering Petrofac increased its Emirates venture stake to 75% in July.

It appears the stockmarket became wary of oil services groups after AIM-listed firms such as Cape and Lamprell sprang nasty surprises that left investors wondering if they could ever rely on directors' outlooks; whether forecasts became dashed by managerial setbacks or 'force majeure' as affected Petrofac in Algeria.

Part of the problem is the market preferring reliable guidance yet the uneven nature of contracts means an aspect of uncertainty, so ratings are prone to fluctuate according to news flow from the sector. Bid approaches for Kentz imply a recent disconnect between market values and underlying values, this being the early stages of an upturn.

Petrofac is therefore well worth watching for further buying opportunities, especially if markets hit a squall with the combined effect of Syria and QE tapering.

For more information see petrofac.com.