Petrofac finals

An oil & gas services company providing design and build for oil and gas infrastructures; operates, maintains and manages assets and trains personnel. I have a holding in my growth portfolio (epic code: PFC)

Petrofac announced their full year results on Wednesday.  Revenue was up 1.4% to $6.3bn with net profit up 2.8% to $650m and diluted EPS up 2.8% to 189.10 cents.


They declared an increase of 1.9% in the final dividend to 43.80c (6.25p) making a full year dividend of 65.80c up 2.8% on last year and covered 2.9x


They mention that their backlog is up 27% to a record level of $15.0bn.  Operating margins were maintained at 12.2% and the business had a return on capital employed of 38.9%, meaning they were turning over their capital employed an impressive 3.2 times (38.9/12.2).  Their return on equity was 36.7%, so since they retain 65% of their earnings, they should have a sustainable growth rate (SGR) of 24% (36.7% x 65%) i.e. an ability to grow at this level without any external finance.  


So far so good, but gone is any mention of achieving their target of doubling their 2010 earnings by 2015.  This would require profits of $862m in 2015 and since they have said   "In line with our previous guidance (see here), we expect flat to modest growth in net profit in 2014 and remain confident of a return to strong earnings growth in 2015." that would require growth of over 30% in that year.


Their business model requires them to lay down a substantial amount of capital alongside their customers on many of their projects.  This requirement has a very negative effect on their free cash flow (FCF), so much so that the FCF generated over the past 5 years has amounted to just $142m - insufficient to pay the dividend for a year.  Consequently the net cash position of $552m at the beginning of this five year period has turned into a net debt position of $727m at the end of 2013.


Currently this net debt position represents a gearing of 36.6% and a comfortable 0.7 of EBITDA, but the operating cash flow is just 11.7% of the debt.  With such a high return on equity and retention of earnings, if working capital and capex profiles are constant, then the business should have sufficient finance internally to grow the business, as demonstrated above in the SGR calculation.  This is clearly not the case, so a compound growth rate in sales of 13.6%pa over the past 5 years has required a $1.3bn switch from net cash to debt.  Implying a fundamental shift in capex and working capital requirements on many of their projects over that period.  


As I posted on 18 November 2013 "...I first purchased PFC in February 2010 for 882p and sold half six months later after it rose 59% from an under-priced share to an over-priced one at 1406p.  It may be time now to sell the remainder of my holding, as the company struggles with generating sufficient cash returns on its investments..."  As the share price has climbed back from the depths of 1089p in mid December to 1371p, I will be looking to exit, as I am uncomfortable with a business that over any reasonable period does not generate sufficient free cash flow.