WorleyParsons is a pro-cyclical engineering, procurement and construction company with revenue strongly correlated to commodity prices.
We have initiated coverage of WorleyParsons with a Buy recommendation and a $16.90 target price, driven by: 1) the recent stabilisation and improvement in commodity prices, which has led to increasing backlogs, with positive implications for near-term earnings growth; 2) our top-of-consensus earnings estimates and our view that an upgrade cycle will be positive for the share price; and 3) the potential we see for corporate appeal in a consolidating sector.
- Business outlook and consensus upgrades – Weakening commodity prices have seen capital expenditure in the global exploration and production, and metals and mining sectors reduce substantially in recent years. This down-cycle has likely been deeper and lasted longer than management expected. However, we now see evidence of an improving outlook as: 1) the market is forecasting single-digit increases in capital expenditure for CY17–20; 2) WorleyParsons’ backlogs grew more than 20% in FY17; and 3) staff utilisation is increasing. We do not believe consensus earnings estimates are factoring in an improvement in the business cycle and, therefore, we expect upgrades over time.
- EPS growth – The stock is trading on an FY18E P/E of 22x, versus its historical average of 18x and peer average of 23x. However, we believe our EPS growth forecasts of 27% in FY18, 30% in FY19 and 12% in FY20 justify the high earnings multiple.
- Corporate activity – We are somewhat unconvinced of the company’s own inorganic growth strategy, but we note WorleyParsons’ largest shareholder, the Dar Group, has increased its share steadily to 23%. The private company has previously looked to acquire WorleyParsons and there remains the possibility that it could return with a firm bid.
Our December 2018 target price of $16.90 is based on the average of our discounted valuation, CY19E P/E multiple of 18x and CY19E enterprise value to operating earnings (EV/EBITDA) multiple 11x. Our forward multiples are in line with historical averages.
We believe the key risk is further acquisitions, with limited evidence to show how much value has been created by the company's inorganic growth strategy.