EUR 850.00 For Business Accounts Only

Morningstar | No-Moat WorleyParsons Bedding Down its Earnings Doubling Jacobs Purchase. FVE Inches up to AUD 9.20.

We increase our fair value for no-moat WorleyParsons by 2% to AUD 9.20 on time value of money considerations. Our fiscal 2019 and 2020 EPS forecasts are unchanged. Including Jacobs ECR, we still assume 5-year revenue CAGR of 18.3% to AUD 11.0 billion by fiscal 2023. However, after normalising for Jacobs, our revenue CAGR for the combined entity is a more pedestrian 3.1%. Worley completed the USD 3.2 billion acquisition of Jacobs in late April 2019 and work to combine the two businesses is underway. The company anticipates annual cost synergies of approximately AUD 130 million within two years, though coming at a one-off AUD 160 million implementation cost. Our numbers fully credit the synergies and exclude the implementation cost from underlying earnings. Our group midcycle EBITDA margin assumption remains 8.3%, ahead of first-half fiscal 2019 actual of 7.0%, crediting success on cost-out programs and operating leverage as the Jacobs-boosted business continues to grow.

Our fair value equates to an unchanged fiscal 2023 EV/EBITDA of 7.5, a P/E of 12.7 and dividend yield of 4.7%. Worley shares have retreated by 12% from February’s AUD 15.30 highs. But even at the current AUD 13.60 share price, they still screen as materially overvalued. We feel the price implies a too aggressive midcycle EBITDA margin of 11% to our 8.3%. We don’t foresee such a high margin given our less bullish outlook for commodity prices and mining and energy infrastructure spending than the market more generally anticipates. Nor the implied higher revenue growth if margins are not the difference.

In its first-half fiscal 2019 results, Worley pointed to 10% half-on-half growth in its 36-month work backlog to AUD 6.6 billion excluding Jacobs, and an increase in pace of ASX-announced contract awards. The backlog growth between the December 2018 half and June 2018 half had slowed, though to a still healthy annualised 6%. But we think regardless the market is too generously valuing this growth.

Worley is trading at an optimistic one-year-forward EV/EBITDA of approximately 10. While this is not out of keeping with the 15-year average to fiscal 2018, that period captures seven years of China-boom in which the average EBITDA per share growth rate exceeded 50%. We struggle to credit similar growth rates going forward. It captured Australia’s LNG construction boom at a time when Australia was closer to a third of Worley’s revenue. Australia is projected to comprise just 10% of the Jacobs-merged group total, diversification and resilience arguments notwithstanding.

We expect net debt, immediately post the Jacobs purchase, sits at approximately AUD 1.5 billion with annualised net debt/EBITDA at around a 1.9 peak. While this is comparatively high for a company operating in the engineering construction space, it is not overly onerous and should only be for a short period in any case. We think net debt/EBITDA could approach a more palatable 1.0 by as soon as fiscal 2021. It would be a great outcome so close to such a large acquisition, thanks in no small part to the recent AUD 2.9 billion capital raising. No net debt should be the long-term aim for a company operating in WorleyPasons’ space and we think this can be achieved by fiscal 2025. This would still accommodate an assumed 60% payout ratio for a 17% 5-year DPS CAGR to AUD 0.55 by fiscal 2023. But the implied 4.0% unfranked fiscal 2023 yield at the current price won’t particularly excite yield chasers.

Worley points to continued improvement in market conditions, with resources and energy customers increasing early phase activity for the next cycle of investment. This is reflected in a number of recent contract awards, the latest an engineering, procurement and construction management contract for Rio Tinto at its Koodaideri iron ore mine in the Pilbara.