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Morningstar | WorleyParsons' Fiscal 2018 Profit Largely in Line. No Change to AUD 6.30 FVE. See Updated Analyst Note from 22 Aug 2018

Despite a number of minor assumption changes for no-moat oil industry engineering specialist WorleyParsons, our AUD 6.30 fair value estimate stands. Underlying fiscal 2018 NPAT increased by 39% to AUD 171 million, marginally below our AUD 177 million expectations. Revenue increased 9% to AUD 4.7 billion, a touch below our AUD 4.9 billion forecast, while EBITDA margin held at 7.4%--weaker than our 7.6% forecast. Revenue growth was driven by the UK IS acquisition rather than underlying improvement. Cash conversion was strong with net operating cash flow jumping threefold to AUD 261 million, ahead of our AUD 210 million target. However, the final dividend of AUD 15 cents was below expectations, bringing the full-year distribution to AUD 25 cents on a lower-than-anticipated 40% payout of underlying NPAT. As with all things mining services, the market appreciated the news and pushed the stock 4.4% higher to close on AUD 19. At that price, we view Worley as materially overvalued.

Worley's contract backlog continues to recover, up 25% to AUD 6.4 billion from AUD 5.1 billion, though the U.K. acquisition again featured. In revenue terms, the year-end 36-month backlog remains comparatively low, however, there have apparently been significant new awards of AUD 400 million since the fiscal year-end, above typical levels. Worley will need the positive trend to continue to build up revenue life in addition to driving growth. Our fair value estimate assumes 1.3% five-year revenue CAGR to AUD 5.1 billion by fiscal 2023 and a midcycle EBITDA margin of 8.6% versus fiscal 2018's 7.4%.

Our moderate revenue growth assumption factors the tail-end of the LNG construction boom, and data showing total Australian energy capital expenditure is likely to now fall precipitously. While Australia Pacific represents just a quarter of Worley's contract backlog, the far larger Americas and Europe, Middle East, Africa segments will regardless have to work hard to offset its decline.

Hydrocarbons account for near 80% of Worley's contracts, followed by infrastructure at 13% and minerals, metals and chemicals the balance.

Worley projects 2018 is the peak year for hydrocarbon (including coal) fuelled power generation, with two thirds of all new power capacity additions now renewables. The company's focus area is in offshore wind, solar thermal, green hydrogen, and power networks. The company does project a return to investment in minerals and metals, but here too Morningstar's outlook for resources is not particularly favourable, including anticipated pull-back in iron ore prices to a midcycle USD 38 per tonne by fiscal 2020 versus USD 68 per tonne spot pricing.

With our outlook on the revenue growth side moderate at best, our forecast for five-year EBITDA CAGR of 4.4% to AUD 435 million rests substantially on margin improvement. Here, Worley says staff utilisation remains on target and cost-out programs are proving sustainable with further incremental overhead savings anticipated. Fiscal 2018 gross margin was held back by lower UK IS margins, but revenue synergies are anticipated in future.
Our fair value estimate equates to a 2023 EV/EBITDA multiple of 6.1. At close to AUD 19.00, the market values Worley on a 2023 P/E of 32, and a price/cash flow multiple of 17, discounted at WACC. The implied 1.9% yield underwhelms, implying anticipation of very strong growth we just don't see. We think the share price implies an unrealistic 15.5% midcycle EBITDA margin if assuming a five-year revenue CAGR of 5%, nearly double our margin forecast and recent historical precedent. Worley is chewing through nearly AUD 5.0 billion revenue annually from contract backlog that must be replaced. The current AUD 6.4 billion backlog equates to AUD 23 per share. And while this backlog contrasts favourably with 2015's backlog of AUD 4.6 billion or AUD 18.80 per share, the share price at that time was below AUD 5.00.