Kentz: A 'mini' Petrofac?

Friday, 25th May 2012 14:20 - by David Harbage

Following on from our review of the Oil & Gas sector on 11 May... ...in which we mentioned the companies which provide services to the constituent companies - notably the majors and the upstream explorers - and last week's reference to Lamprell's disappointing trading on 16 May, we felt a more positive perspective of the industry was warranted. Searching for tomorrow's giants amongst the minnows within the stock exchange listed universe is, of course, not easy and can be as hazardous as drilling for natural resources. But little-known Kentz, which has been described as a mini Petrofac (a FTSE100 constituent, whose market capitalisation is ten times bigger) merits investigation. Why look at the sector? Likening the oil services companies to those that provided the 'picks & shovels' to the gold miners of California in the 19th century might understate the technical capabilities of today's support businesses, but clearly illustrates the critical and relatively reliable nature of these firms (by contrast with the explorers themselves). If you, dear prospective investor, are attracted to the argument that the world's increasingly scarce natural resources - such as oil, gas and other minerals - will require extraction and production capabilities in ever more extreme geography and climate, then you will no doubt agree that increasingly specialist, skilled contracting skills will be required. As such, companies with a proven experience of delivering construction and engineering projects in remote locations, safely on budget, represent long term growth opportunities. Founded in 1919 in Ireland, and previously known as MF Kent, Kentz listed on the Alternative Investment Market in February 2008, before moving to a full listing - and membership of the FTSE250 index - in September last year. Employing 14,000 people in 29 countries, the company has comfortably beaten analysts' forecasts in its short life as a stock market listed firm. Profits have risen from 21 US cents in 2008 to an impressive 50 cents in 2011, and the share price has progressed in similar manner from 127p in 2008. The company provides a broad range of engineering, construction and technical support services across the oil & gas (accounting for 45% of 2011's revenue), mining & metals (24%), petrochemicals (16%), power (7%) and other product industries (8%). These capabilities typically surround structural, mechanical, electrical, instrument and piping construction in upstream operations; extending from complex design to introducing new technologies into older facilities to decommissioning refineries. By geographic region, turnover last year arose: Africa 39%, Middle East 29%, Australasia 23%, North America 5%, and remainder 4%. Kentz management put great store on its ability to win new business from existing longstanding satisfied clients (which it terms natural growth) who tend to be blue chip companies (including Chevron, ExxonMobil, Quatar Petroleum, Woodside) and, looking at its US$2.4bn backlog and US$10.5bn of prospective business over the next 18months, a bias towards its traditional oil & gas sector and the Australasia & Middle East regions - where it has operated for more than 25 years - re-emerges. Last calendar year, Kentz produced US$79.4m pre-tax profit on turnover of US$1.37bn, underpinned by a strong balance sheet featuring US$225m in cash. The trading update released on 18 May suggests that 2012 will maintain the strong track record, notably via LNG contracts in Australia, oil sands in Canada, coal in Mozambique, nickel in Madagascar and, looking further out, potential plant rebuilding work in Iraq. As intimated above, earnings per share of 50.61 cents in 2011 (40.66cents in 2010) appear set to progress higher, based on brokers' forecasts towards 55cents in the current year and on to 63.5cents in 2013. The latter number is a consensus average (based on 9 brokers who monitor Kentz, where 6 say Buy, and 3 say Hold), which equates to a price/earnings multiple of 9.4 times on the current 373pence share price, an attractive PEG (Price/Earnings relative to the growth rate) ratio of 0.6, with double-digit dividend growth likely - given that the current payout is covered 4 times by profits. By contrast, FTSE100 constituent Petrofac is researched by 19 brokers (11 currently say Buy, 6 Hold and 2 Sell), and its valuation is more demanding - as the shares are valued on a PE multiple of 11x forecast 2013 earnings. The (John) Wood Group is another comparable business, of near FTSE100 size and probably better known by investors, but stands on a PE rating of 11.5x based on anticipated 2013 earnings (15 brokers cover the stock with 7 Buys, 6 Holds and 2 Sell recommendations). Like Wood Group and Petrofac, the shares of Kentz have performed very well over the past three years but have fallen back more recently. In the last week of October 2011 Kentz stock reached an all time high of 505p, but at the time of writing have touched a 1year low of 373p. It might be that the unspoken, but undeniable and logical, connection with the oil price has dictated this performance. Last week's revelation from another player in the industry, Lamprell, will not have helped - and experienced investors will appreciate that smaller businesses will always feature higher inherent risk of surprise (be it adverse or positive). Bigger institutional investors cannot typically invest in companies of Kentz size, especially where much of its stock is closely held. However this situation has been eased and aided by Kerbet selling 15m shares (12.89% of equity) on 4 April, as strong institutional appetite at 430p prompted an upgrade from initial plans to sell 12m. The sale may have fazed some personal investors, and have been a contributing factor to weigh on sentiment, but is set to be a positive as it increases supply to both fundamental bigger investors and potential trade buyers. Long term investor Kerbet, incidentally, still owns 13.64% of Kentz and represents the vehicle of the chairman and another non-executive director. We would encourage prospective investors to carry out their own due diligence, beginning with the Annual Report and Accounts and via websites (including LSE's RNS, fundamentals, charts and chat pages) build up an appreciation of its business and the views surrounding its proposition. Considering its merits and potential risks - via the SWOT method of listing strengths, weaknesses, opportunities & threats - against the current valuation and growth rates (relative to peers and the wider market), prompts this writer to believe the market is currently undervaluing Kentz stock's worth. The prospect of a larger rival, perhaps even the global leader Schlumberger, deciding that Kentz would represent a useful bolt-on (skilled people feature 400 design engineers) and earnings-enhancing (consider cash balance impact on return on equity) acquisition is also a real possibility. On fundamentals Kentz stock would seem, to this commentator, to be worth 450p per share - but a predator would surely have to pay north of 5 pounds to gain control. However two common stock market phrases come to mind: It takes two to make a market; and The market (price) is never wrong. so we fully accept that other, less optimistic opinions carry sway, and will let the reader make their own considered judgement. We would be interested in your views on Kentz, be they supportive or otherwise, and the usefulness of stock-specific articles such as this - by using the Comment space provided below.