Edmond Jackson's Stockwatch: An oil industry turnaround worth backing

Two years after a debacle of five profit warnings, Dubai-based maker of "jack-up" (self-elevating) oil rigs Lamprell has delivered better-than-expected 2014 interim results, although brokers have remained cautions to upgrade their stances - typically "hold" or "neutral".

This has been the case since the shares - now back in the FTSE 250 index - began improving from about 120p last springtime, currently to test 180p. Such a chart contrasts with those (mainly cyclicals) I have been engaging where 2013 saw a sharp rise - helped by speculation - then 2014 has seen consolidation or a drift down.

The context is Lamprell having traded between 240p to 340p in late 2010 to early 2012, although a rights issue last May increased shares issued by over 30%, making it more challenging to restore earnings per share to 17p (see table). A previous management expanded too quickly and hit problems, but I thought Lamprell was a good example of the adage to buy into an industry leader suffering short-term "fixable" set-backs.

In January 2013 I noted how a banking-waivers and contracts update had bolstered recovery potential at about 110p, then in March 2013 a highly experienced new chief executive was appointed who has refocused the business on delivering straightforward rigs for quality clients.

Reporting in US dollars, the first half-year has seen earnings per share recover to 26.9 cents (16.4p) against 2.5 cents in the first half of 2013 as revenue rose 24.8% to $632.3 million, helping operating profit jump 178% to $53.4 million and continuing operations' profit before tax and exceptionals up 216% to $46.5 million.

Positive impact

It is encouraging to read of "strong operational performance in all core markets" despite lower revenue anticipated for the second half due to the timing of rig build cycles and reduced activity in construction markets. Four recent projects were delivered ahead of budget, helped by productivity enhancements.

One key project to mind is a second Caspian Sea rig where the first incurred losses in 2013: "We are working hard towards the scheduled delivery date and, if delivered successfully as planned, this could have a material positive impact on the 2014 financial results."

The essential point is Lamprell is now on a sound footing without the reputational loss feared likely after 2012's debacle; hence it becomes possible to consider how it may capitalise on industry activity in the longer term. Note that on 26 August, Iran's petroleum minister followed the chief executive of Saudi Aramco, the world's largest state-owned oil company, warning that recent declines in crude prices will be short-lived.

Seasonal fluctuations were cited, although Iran and Saudi Arabia being the largest producers in the OPEC cartel also raises the question whether output could overall be managed to help squeeze prices higher. "To meet forecast demand growth and offset decline, our industry will need to add close to 40 million barrels per day of new capacity in the next two decades."

Useful upside

This implies useful upside for industry equipment providers which, well-managed, can offer lower risk than explorers. Besides attractive fundamentals, sentiment towards industry servicers' shares also tends to firm with oil prices as the stockmarket anticipates more industry activity. Rig stock is considered elderly, so increased drilling is likely to prompt replacement.

Lamprell is well-prepared for such a scenario. Last May, a rights issue at 88p raised £71.6 million not only to cut borrowing, but also in support of capital investment "to leverage the company's strong position... particularly in new build jack-up rigs and offshore construction markets." Enhanced working capital availability "would enable the group to access a larger addressable market and support additional project wins."

This ought to benefit 2015 onwards, so if the industry context proves benign then possibly the flat profit/earnings outlook for then is conservative. The best indicator to watch is the "backlog" (i.e. order book) as the stockmarket will be sensitive to rates of change. At end-June it was $1.2 billion against $0.9 billion at end-2013 with the bid pipeline rising from $4.7 billion to $4.9 billion. 2015 revenue is expected to remain heavily weighted towards new build jack-up rigs, while rig refurbishment is becoming increasingly price-competitive: "We will only take on such projects which include a balanced and reasonable level of risk and reward."

The chief risk is global economic recovery being interrupted say by troubles in China and possibly other developing countries if the dollar rises with higher US interest rates; also recession grinding on in the eurozone - exacerbated by the Ukraine crisis and tit-for-tat trading embargoes. Mind this stock remains ultimately a cyclical.

With restrictions on dividends being removed as term loans are paid down, no dividend is likely for 2014, but the board says it will restore payments "at the most appropriate time". This is suitably vague although brokers are pencilling in a 2015 dividend which would underline a successful turnaround. The board is weighing trading performance and investment needs, the lack of dividend does not imply any cash constraint: at end-June net cash was $280.6 million, up from $183.8 million at end-2013. A refinancing completed in August has also helped put Lamprell on a strong footing for growth.

So a textbook turnaround is being achieved; the industry context increasingly determining a share price target; and where fears of the impact of the shale revolution on oil prices look to be galvanising OPEC members into production cuts, to manage oil prices back up. It's speculative but 200p+ looks a more likely medium-term scenario than a drift back to 150p.

For more information see lamprell.com