Oil service sector

Is there value in the oil service sector?

The decline in the oil price from a 52 week high of $120 a barrel for Brent Crude in May of last year to $103 on Friday, has meant that most companies associated with the oil industry have suffered.  Does this offer value within the oil service sector?  Three companies quoted on the LSE would appear to be at bargain prices compared to their growth prospects – Petrofac (PFC), Kentz (KENZ) and Amec (AMEC).  Although the price of oil will affect the earnings of the oil majors, such as Exxon and Shell, at the current price the majority of programmes and activities will continue with most of their plans built around a price of $80-90 per barrel.  They still need to spend money with these oil service companies.

Proof of this is the order book for future delivery of those three companies at 31 December 2012:

PFC - $11.8bn ($10.8bn last year) represents 1.9 times 2012 annual sales.

KENZ - $2.57bn ($2.4bn last year) represents 1.8 times 2012 annual sales.

AMEC - £3.6bn (£3.7bn last year) represents 0.9 times 2012 annual sales.

	PFC	KENZ	AMEC
	$	$	£m
Sales	6,324m	1,413k	4,158m
Earnings	632m	70k	216m
Market Cap £	4,530m	444m	3,000m
Share price	1331p	378.4p	1009p
Normalised EPS	$1.79	$0.59	77p
2013 growth	11.80%	15.70%	15.80%
P/E ratio	10.3	8.72	11.3
2014 growth	13.60%	9.76%	11.90%
P/E ratio	9.04	7.95	10.1
Rolling PEG	0.79	0.62	0.76
PBV	4.53	2.48	2.78
Yield	3.11%	2.48%	3.62%
ROE	47.5%	27.7%	17.2%
Operating margin	12.1%	5.5%	5.8%
5 yr NBV + Div return	34.8%	35.4%	12.5%
FCF return on NBV	21.2%	(a)15.0%	10.9%
(a) Incl JV cash rec'd 45.7%

 

PFC by sales, earnings and market capitalisation is the largest of the three; this can be an important criterion as many of the contracts are substantial in size and do require investment in working capital.

AMEC has the highest forecast growth in 2013 of 15.8%, although what would appear to be the weakest order book compared to the other two at 0.9 times last year’s sales.  PFC has the highest growth for 2014 of 13.6% and it is worth mentioning that the management have set a target of $862m by 2015 a 3 year CAGR of 10.9% pa.  AMEC’s management on the other hand have set a target of 100p EPS by 2014 a 2 year CAGR of 14% pa.  There is no management target from KENZ.

KENZ offers what appears to be better value – a lower P/E ratio (that’s the price divided by the earnings per share) over the forecast two years, a lower PEG (so you are buying more growth for the P/E ratio you are paying) and a lower price to book value (PBV) that’s the price you are paying for the net assets of the company. The book value is also represented by the equity of the business where all the money from issuing shares ends up, along with all the earnings after paying any dividend.

PFC appears to have a higher quality business with a better operating margin of 12.1% and ROE of 47.5%.

The last two numbers in the table represent:

the 5 year CAGR in the NBV and the dividends paid (that’s what the long term investor receives – dividends and a share of the equity, remember the book value is represented by the equity)

and the second is the free cash flow (free cash flow is operating cash flow less capital expenditure) return on the NBV.

If the free cash flow number is a lot less than the other, then one should always investigate the reason. In KENZ’s case this is due to cash received from their joint ventures (they are part owners in various projects and the cash received, usually in the way of dividends, is not part of the operating cash flow of the business).

So with the adjustment for the KENZ JV cash being received, they have the better returns over the 5 year period.  Although it should be borne in mind that KENZ may not control those JV cash flows (2012 JV cash received was lower than 2011).

A further point to be borne in mind is that PFC over the past three years have not generated any free cash flow, due to the substantial working capital  and capital expenditure investments they have made over that period.

AMEC’s 5 yr NBV + dividend return has not been helped by their recently completed share buy-back (£400m of purchases), where they have gone into the market to purchase their own shares. This was started when the company had a PBV (price to book value) of 2.53, not a particularly attractive price.  Share buy-backs immediately deplete the book value of the business and earnings and dividends per share are improved over time.  I’ll comment on buy-backs more fully in a separate post.

Finally the outlook statement from their 2012 results:

PFC:  “…Overall, we are confident in our prospects for the coming year and beyond. We expect to deliver good growth in net profit in 2013 and remain on target to more than double our recurring 2010 Group earnings by 2015…”

KENZ:  “…We anticipate that 2013 will be yet another prosperous year for Kentz. The global economy continues to be uncertain, but I am impressed with the resilience of our organisation to adapt to these difficult conditions…”

AMEC “…We continue to expect good revenue growth in the conventional oil & gas market in 2013, offsetting softening in the oil sands and mining markets. We remain on track to achieve our targeted EPS of greater than 100 pence ahead of 2015…”

It may be a difference of style, but PFC and AMEC sound a little more bullish than KENZ.

So to summarise:

Both PFC and AMEC meet the requirements for my income portfolio, but KENZ fails as its prospective yield is less than 3% and it only has 4 years of dividend growth.

All fail for the growth portfolio, obviously on 1 yr relative strength and on an EPS 1 Yr rolling growth rate of 15% or greater, although AMEC at 14.4% is very close and any forecast upgrades from brokers may tip it over.

Despite the buy-backs I would probably plump for AMEC in an income portfolio, due to the concern over the 3 year free cash flow of PFC right now.

I do hold PFC in my growth portfolio having bought at 882p in February 2010 and sold half my holding in Aug 2010 at 1406p.  They are currently being reviewed for potential disposal.