EUR 850.00 For Business Accounts Only

Morningstar | U.S. Antitrust Clearance Boosts Chances of Jacobs Bid Success; No Change to AUD 9 FVE for Worley

In October 2018, we upgraded our fair value estimate for no-moat WorleyParsons by 43% to AUD 9 per share. This assumes an announced AUD 4.6 billion purchase of chemicals and resources engineer Jacobs ECR goes ahead. The combination will double Worley’s earnings and create a global leader in professional project and asset services in resources and energy. It will also generate cost savings of AUD 130 million per annum, which we credit in our valuation.

Our FVE has limited downside risk. AUD 3.75 of uplift is already banked via a deal-associated AUD 2.9 billion capital raising being undertaken at a large premium to our prior FVE. The capital raising was completed in mid-November and stands whether the Jacobs deal goes ahead or not. In fact, were the Jacobs deal to stall, it would be positive to the tune of AUD 0.75 or 8% to our FVE, as we think Worley is somewhat overpaying for Jacobs based on our discounted cash flow model. We valued Jacobs ECR at AUD 3.7 billion including synergies, 20% below the AUD 4.6 billion face value purchase price, which in our opinion represents a too-high pro forma fiscal 2018 enterprise value/EBITDA multiple of 11.5 before synergies. Overpayment is not entirely offset by a reduction in the group cost of equity assumption to 11% from 13.5% in recognition of the earnings diversification and reduced cyclicality Jacobs ECR brings.

But upside risk to our FVE is diminishing, with Worley announcing in December that it has received U.S. antitrust clearance. There are still regulatory approvals outstanding in several other countries, but the U.S. clearance is a major step. Our unchanged FVE equates to a 2023 EV/EBITDA multiple of 7.8 on the expanded group. Worley shares have fallen by one fourth since our last note but at AUD 13.15 remain overvalued. On our forecasts, the market values Worley on a 2023 price/earnings of 18 and a price/cash flow multiple of 17, discounted at weighted average cost of capital. We still think this too high.

The implied 3.3% dividend yield underwhelms, implying anticipation of strong Jacobs-adjusted growth we just don’t see. At the current price, for the combined group we think the shares imply an unrealistic 11.5% midcycle EBITDA margin if assuming a five-year revenue compound annual growth rate of 3.5% normalised for Jacobs, nearly 30% above our 8.7% margin forecast. And that margin forecast is already higher than the 7.0% five-year historical average to fiscal 2018.

Worley has favourably announced a number of new contracts over the last couple of months, although as is usual, value is not disclosed, making it difficult to determine materiality. In November it won a four-year contract extension for operations and management of the Collie power station in joint venture with Broadspectrum, a new terminal services contract for BP in New Zealand, a consultancy services agreement for King Abdullah City for Atomic and Renewable Energy in Saudi Arabia, an engineering, procurement, construction, and installation contract for Lundin Norway’s Edvard Grieg platform, E&C and EPC contracts for ConocoPhillips in the North Sea, a fabrication and construction contract for a sour gas plant in Canada, and an EPCM services contract for SABIC in Europe. This was followed up in December with an engineering, procurement, and construction management contract to build a new acrylate styrene acrylonitrile facility in the United States.

The most that can be gleaned from these announcements is their number, eight in the space of just two months. This is considerably higher than the average for the last three years, reflecting improved market conditions and customers increasing early-phase activity for the next cycle of investment. On a three-month trailing average basis, the average number of monthly announced contracts over November and December was 2.6. This is more than double the 1.1 average for the three years to December 2018. This gels broadly with our forecast for 3.5% normalised group revenue growth to fiscal 2023, in contrast to an average annual revenue decline of 8% for the five years to fiscal 2018. But we stress the relationship is crude at best, contributing to our high fair value uncertainty rating.