Questor: Petrofac delivers but the valuation is up with events

Petrofac

£10.30 -33

Questor says HOLD

Full-year earnings at oil services group Petrofac will be up by "at least" 20pc as the company continues to win new orders, the company said yesterday. Questor would not be surprised if the actual figure is nearer to 25pc.

The company's backlog at September 30 was for work valued at about $8.5bn (£5.1bn). The lion's share of this – some $7bn – is in its engineering and construction business.

Petrofac has a strong balance sheet, with about $1.3bn in the bank, boosted by advance payments for work. The company's challenge now is to deliver on these new orders in the next two years or so and continue to win new work for the future.

Yesterday's trading update underscored the fact that management is executing its strategy well – and this has been reflected in its share price performance. The shares are up by more than 300pc since their trough in December of last year.

Questor has been a big fan of Petrofac shares this year, advising investors to buy on numerous occasions as the shares charged ahead. The shares were first recommended on March 10 at 468p and latterly at 905p in August. They are now 120pc ahead of the initial recommendation price.

The shares are trading on a December 2009 earnings multiple of 17.7 times, falling to 13.2 next year. This is at a significant premium to its peer Wood Group, which is trading on a current-year earnings multiple of 14 times. However, this premium is probably warranted.

There is potentially more upside from here, although the shares are likely to be up with events for now.

There is also concern about global stock market valuations after the recent strong run. The only green shoots Questor is looking for are a change in the direction of unemployment data. This is unlikely to occur for some time and until then any recovery will be fragile.

There is an argument that an improving oil price will give companies in the sector more confidence to invest in new projects – generating more business for Petrofac. This is true, to some extent, but this argument may be a little overcooked.

Questor would be very surprised to see the oil price spike much higher in the short term, because the world has excess capacity. Speaking on the fringe of an oil conference a couple of weeks ago, Christof Ruhl, BP's chief economist, said that a significant spike is unlikely in the next few years because of the current glut of oil.

Mr Ruhl argued the case well. He said there would soon be six million barrels per day (bpd) of spare production capacity worldwide. In the good years, global demand was rising by 1.2m bpd a year and, said Mr Ruhl, "even if the good years were to return tomorrow, it would still take more than three years to burn through that spare capacity and to create markets as tense as they were a year ago."

Petrofac's business is well managed and focused – and the visibility of earnings is impressive due to its large order book. Questor will continue to review prospects for the group, but after such an impressive rally, the stance on the shares – for now – is hold.

Unilever

£18.41 -18

Questor says BUY

Significant growth in the UK economy is not going to return for some time. That's why Questor believes investors should look for growth abroad – especially in emerging markets. Unilever is one company that fits the bill.

The group generates more than half of its sales in emerging markets. This proportion is likely to rise in future years. The strategy of moving into these high-growth markets is sound.

Speaking at a conference in London last week, Paul Polman, Unilever's chief executive, said that he had a "prudent" view on the outlook for economic recovery and that UK household budgets were likely to be tight for some time.

He also said that the next billion customers would come from the fledgling economies, noting that whereas exposure to these markets had once been seen as risky, it was now an advantage.

Mr Polman said he is particularly focused on Russia, India, China and Thailand, pointing out that it is likely that there will be an increasing flow of brands from Eastern markets to the West.

Unilever recently made its first major acquisition in nine years, announcing the purchase of the soaps and personal-care businesses of US group Sara Lee – which includes the Radox and Badedas brands.

About 85pc of the sales of the unit are in Western Europe, but the company plans to introduce these brands into growth markets. The brands are also more at the value end of the spectrum, increasing the group's offering in this area.

Significantly, it is a sign that management is actively seeking growth.

The company has been involved in significant cost-cutting and restructuring for some time, but now, as one analyst put it, Unilever "has moved from the back foot onto the front foot".

The shares are trading on a December 2009 earnings multiple of 16 times, falling to 14.4 next year, which seems reasonable. The current yield is 3.8pc.

Unilever shares were first recommended at £15.03 on November 26 last year and they are up 22pc since their initial recommendation. The stance remains buy.