Edmond Jackson's Stockwatch: Kentz a quality long-term growth play

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Ahead of reporting prelims on Monday 24 March, it is interesting to consider how forecasts have been raised for Kentz Corporation, especially as its price/earnings (P/E) multiple of about 20 times drops to 12 for its 2014 outlook.

Moreover, the price/earnings growth (PEG) ratio, a classic measurement of growth stocks, drops from a fairly full 1.6 times for the expected 2013 outcome, to a cheap 0.3 for 2014 - assuming forecasts are fair.

The PEG is considered to provide a better picture than the P/E because it takes earnings growth into account, a ratio below 1 generally being attractive.

The question is whether this arises for Kentz mainly as a result of its acquisition of Valerus Field Solutions at the end of 2013, which is set to boost 2014's figures, but what might happen next?

Fending off a takeover

It is worth considering the context to better interpret Monday's results, especially any guidance its management may offer.

Last summer, Kentz managed to fend off bid approaches from Amec and M+W Group, a positive event that implied industry sought control of the company at this stage in the economic cycle.

However, management was able to convince institutional shareholders that Kentz should stay independent.

The pipeline of opportunities was up 14% in the first half of 2013 as clients continued to invest, and a record US $4.5 billion (£2.7 billion) of bids were submitted in the second quarter.

The "backlog" or order book grew 8% in the first half of 2013 and 12% revenue growth was projected for the year.

Revenue expectations

A 23 January pre-close update did not raise 2013 revenue expectations higher and earnings per share were cited in line with management expectations - with brokers' analysts looking for about 11% growth.

The medium-term scenario looks more influential on Kentz's value however, where the backlog is cited up 19% to $3.1 billion and order intake up 29% to $2.2 billion. The jump in forecasts, 60% growth in 2014 pre-tax profit and 45% growth in earnings per share, relates additionally to the end-2013 acquisition of Valerus Field Solutions for $435 million.

This US-based company increases the group's exposure to high-value, high-margin contracts and US shale gas which is a new market for Kentz. For context, the group's dollar equivalent market value just before the deal approached $1.2 billion. Valerus was bought principally with a new $400 million term loan - i.e. no earnings dilution - which Kentz could support given its strong balance sheet with $220 million cash last June.

In 2012 Valerus made $51.5 million operating profit on $492.5 million revenue so this initially looked a good deal priced below annual sales and compared with $1.56 billion 2012 group revenue for Kentz. A deal of this scale with the prospect of group margin enhancement does indeed re-rate earnings, so 2014 forecasts may not be lofty.

Significant contracts

The last two months have seen 5 significant contracts, two involving Valerus: at end-January, a $62 million shale gas related contract in West Virginia and on 19 March a $38 million contract involving a production plant in Venezuela which is intended to be operational by the fourth quarter of 2014.

It tricky to decipher the financial upshot and when, but the momentum of contracts appears to have picked up in the last six months. On the basis of 2012 group revenue, Africa, the Middle East and Australasia were the principal sources, then the Americas - albeit which contributed marginally the most profit.

As political risk does not appear especially high and energy supply will continually need to be improved, Kentz should prosper long-term.

Mind that in the short- to medium-term there are financial risks surrounding developing countries, China especially, which are able to impact sentiment towards resources and related shares.

It is possible that 2014 sees volatility for Kentz, although it brushed aside the New Year plunge in emerging markets.

Temporarly slide

Mind also, this share has previously appeared well-positioned yet temporarily slid. Two years ago, excellent 2011 results were announced and the end-year backlog had soared from $1.6 billion to $2.4 billion.

Kentz was making $79 million pre-tax profit on nearly $1.4 billion revenue against a share price of 470p, and I followed the results with a 26 March 2012 comment piece noting that its long-term capital growth potential made Kentz "a priority 'buy' especially when markets turn jittery."

For no serious reasons the stock was then hit hard to 325p in the second quarter of 2012 although I had initially drawn attention at 240p in June 2010 when the P/E was 11.5 falling to 10 times and again a year later at 385p.

So this sector has a capricious aspect, with the main risk for 2014 likely to be Chinese credit defaults creating havoc for commodity sentiment - even energy markets.

But if Kentz management can impress on Monday, as regards to its outlook, investors and traders alike may be attracted here anew.

Corporate events of the last six months affirm Kentz as a quality long-term growth play, with risk overall on the upside; one to be watching for its results and also its shares during market turbulence. Chinese-related fears could provide another fine buying opportunity.

For more information see kentz.com.