It still looks too soon to buy most mining-services stocks, despite horrendous share-price losses in the last 12 months. What appears to be screaming value is more likely a value trap, as falling commodity prices see more resource projects delayed or cancelled next year.
WorleyParsons could be an exception at the current price. After slumping from a 52-week high of $22.70 to $13.25, the company is close to value territory. It’s not quite there yet – but near enough to be on the radar of value investors.
Macquarie Equities Research this week noted that WorleyParsons is almost back to levels it traded at (in terms of share price and Price Earnings relativities) during the 2008 Global Financial Crisis – a remarkable fall for a well-regarded provider of engineering and professional services.
WorleyParsons has a one-year total shareholder return (including dividends) of minus 36 per cent to October 29, 2014. The three-year average annual loss is 18 per cent and over five years WorleyParsons has cost investors 9.5 per cent a year on average. By any measures, these are awful losses for a company that had earlier produced stellar capital growth. Over 10 years, the total shareholder return is an annual 13 per cent.
Macquarie has a 12-month share price target of $18 for WorleyParsons and says the “valuation is attractive to medium-to-long-term-focused investors”. If Macquarie is correct, WorleyParsons will deliver a 42 per cent total shareholder return (including dividends) from the current price.
I’m not as bullish. WorleyParsons has high leverage to energy-sector projects, which are hurt by the lower oil price. More than 70 per cent of its revenue comes from the hydrocarbons sector. Continued volatility in energy prices will be a significant headwind in 2015.
Chart one: WorleyParsons
Also, after a string of earning downgrades, it is too early to say the worst is over for WorleyParsons. It is hard to find catalysts for a significant re-rating this financial year given lingering earnings uncertainty and ongoing earnings downgrades from other mining-services providers.
Morningstar lowered its profit forecast for WorleyParsons by about 5 per cent after the FY14 result because of the downturn in demand from the resource sector for engineering and construction management. It had a $17 fair value for the stock in late August.
Nevertheless, WorleyParsons could be a good long-term buy for investors who can weather softer earnings growth in FY15 and FY16. Most of this outlook has been factored into the company, although further short-term price weakness would not surprise.
Although it has been plagued by earnings downgrades, WorleyParsons is among the highest-quality resource-services provider on ASX. The Return on Equity has averaged just above 15 per cent over the past five financial years – a solid result in a terrible mining-services market.
ROE of 12 per cent in FY14 was well down on the 23 percent ROE in FY09, but many mining-services companies would be happy with a similar return on each dollar of shareholder funds invested given the sector’s downturn.
WorleyParsons’ balance sheet is in good shape, with net gearing of 23 per cent in FY14, and net interest cover of 7.5 times. Balance-sheet strength is vital for all companies, and especially for mining providers that need the firepower to withstand lower mining-investment activity as commodity prices fall, and to capitalise on acquisition opportunities. A share buyback would make sense given WorleyParsons’ balance-sheet strength, free cash flow, and lower share price.
Re-rating catalysts next year could come from an improved oil price and a lower Australian dollar. More than 80 per cent of WorleyParsons’ revenue is earned outside Australia and New Zealand, making it a beneficiary of a lower currency. Further contract wins and signs of profit-margin improvement would also support a share-price recovery later in 2015.
Conservative, long-term value investors might find value in WorleyParsons now. At the current price, Morningstar forecasts a 6.8 per cent partially franked yield in FY15, meaning investors should at least enjoy a decent dividend while they wait for stronger capital growth.
Active investors might wait for lower prices in WorleyParsons as sentiment towards mining services deteriorates even further in the next six months. There’s no urgent reason to buy it just yet, but this quality company is getting closer to bargain territory.
Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at October 29, 2014.