Fat Prophets take some profits

Having secured more ‘awards’ than big screen hit Avatar, 2009 will be a tough act to follow for oil and gas support services company Petrofac (LSE, PFC). The group’s shares finished the year as one of the FTSE 100's top performers and currently sit 90% higher than when we made our initial buy recommendation late 2007. Although the company has begun 2010 on the front foot, astute portfolio management dictates that, in light of such robust gains, a reduction of exposure is prudent… despite our continued bullish outlook for the shares.

Given the extent of the equity rally of 2009 the prevailing market pullback is no surprise however the length of time the market will remain caught in consolidation is more uncertain. In our view, the current bout of volatility will not be the precursor for a precipitous decline and should not be feared. Instead such times often provide the platform upon which portfolio adjustments can and should be made; changes which may well provide the catalyst for out performance come the year end.

Members will be aware that pre empting a bout of market weakness, our recent recommendations have more or less all emanated from ‘defensive’ areas. With economic indicators providing mixed signals, a rotation into internationally exposed large cap defensives shares which boast a decent dividend yield will continue to gather momentum over coming weeks.

Petrofac ticks many boxes, so why sell?

Good question…. particularly given that we remain firm believers in the company’s operational ability and can only see earnings continuing to strengthen. Whether the share price will replicate the stellar performance since our initial recommendation at 500p back in November 2007 is another matter entirely. Instead, our heads are being turned by the harsh treatment currently being dished out to much of the much of mining sector.

As today’s ‘buy’ recommendation of Rio Tinto on a pullback to 2900p illustrates, we are following the policy of buying on weakness and further rotations in the mould of ‘Sell Petrofac; Buy Rio’ will follow should prevailing conditions not abate. This type of transition becomes easy to understand considering that whilst the FTSE 100 has dropped by 8% since reaching 5600 around 3 weeks ago, Rio Tinto shares have fallen by 19% whilst Petrofac shares have undergone a relatively marginal retracement of 3%.

Potentially, such resolve represents a reason to stick with Petrofac… and so by selling half we remain exposed to the company’s ability to secure contract after contract whilst guarding against erosion of what are significant profits.

Taking a look at the technical picture the Petrofac’s phenomenal performance of 2009 looks spectacular, with shares more than tripling in value in what has been a near parabolic uptrend.

The daily chart shows that the recent uptrend since late June has stalled around the 1050p level and has formed a sideways consolidation channel with the 940p level acting as channel support. Even after such a phenomenal run there remains significant potential to the upside on a break out of this channel.

As a reminder to Members, Petrofac delivers services through seven business units: Engineering & Construction, Engineering & Construction Ventures, Engineering Services, Offshore Engineering & Operations, Training, Production Solutions and Energy Developments; and is a leading international provider of facilities solutions to the oil and gas production and processing industry. Since formation in 1981, the company has garnered ‘know how’ across the full life cycle of oil & gas assets.



From designing and building oil and gas facilities to operating or managing them and training personnel, the company has capabilities on numerous planes. Furthermore, where synergies are identified, the group co-invests to provide additional alignment.

Petrofac retains quasi-defensive positioning within the energy industry and such is well suited to ride out any prevailing economic uncertainty. The company’s main asset is the financial clout of those it serves and both the company’s order book and bid pipeline have continued to forge ahead at a rate of knots.

Petrofac’s clients include national oil companies as well as heavy hitters from the private sector and are not the type to adjust expenditure plans in the wake of market volatility. Whilst earnings for much of the energy industry remain at the mercy of the gyrations of commodities markets, Petrofac are not so leveraged.

Although a robust oil price certainly bodes well for company, it is not the be all and end all. As long as the oil price remains ’high’ and the company’s clients remain active, Petrofac’s cash register will continue to tick over.

Indeed the contract awards continue to flow. The company has just landed what could eventually turn out to be its biggest contract, providing engineering expertise to Turkmenistan’s state energy company Turkmengas in the development of the South Yoloten gas field, one of the biggest in the world.

State owned entities such as Dubai Petroleum and Kuwait Oil Company (both clients) tend to have deep pockets and Turkmengas is the latest to tap into Petrofac’s expertise. The recently signed first phase contract is worth around US$100 million but it’s the second phase said to be worth around US$4 billion which will be the major catch when it is signed and sealed.

Whist the company’s contract wins tend to be in the hundreds of millions or billions, management remain prudent with cash outflows.

As we alluded to in our most recent coverage in FAT 315 management has the means to spend big – around US$1.2 billion in the bank at the year end - but prefer to make strategic bolt-on acquisitions. To use a Premier League football comparison, Petrofac’s approach to making acquisitions is less Manchester City or Chelsea but more Arsenal.

The 2007 purchase of a 51% interest in SPD Group, a specialist provider of well operations services, resulted in a £3.6 million outlay. Whilst the 2008 ‘signings’ of Eclipse and Caltec involved initial cash outlays of just £6 million and £15 million. After further considerations, the total value of the 2008 deals will not exceed £16 million and £30 million respectively.

Much like Arsenal supremo Arsene Wenger, the top brass at Petrofac make additions to the stable which on the surface offer seemingly limited performance uplift. However, once integrated into the largely organically developed portfolio of assets, new additions have a habit of becoming highly earnings accretive.

The latest addition to the ‘squad’ is Scotvalve Services a UK-based services company signed for an upfront fee of £3 million with £2 million in add-ons should agreed performance targets be met.

Scotvalve provides the servicing and repair of oilfield pressure control equipment and has the capability to cater to the oil & gas sectors in the Middle East and North Africa an area of particular strength for Petrofac.

All factors considered, our decision to reduce our Petrofac exposure by half is certainly no reflection on what is a robust long term outlook.

Having secured more than US$6 billion worth of business in 2009, Petrofac has seemingly dismissed the notion of a global financial crisis induced reduction in energy investment. The group’s backlog has almost doubled in a year and, with the colossal Turkmengas deal waiting in the wings, cash flows and earnings are set to remain robust for some time yet.

However with prudent portfolio management a key consideration, having initially recommended Petrofac shares at 500p, we advise Members to reduce exposure by half at around 952p.