We recently researched Worley (ASX:WOR) in The Dynamic Investor after a period of share price weakness. We concluded that the shares presented an opportunity. This view was based on two factors. Firstly, that the medium-term EPS growth profile remained unchanged from prior to the recent sell-off. Secondly, market concerns about stalling growth and project delays were overdone.
With the shares having recovered strongly since our recent report, do current levels still present an attractive entry point?
About Worley
Worley is a provider of global engineering, advisory and project management services to the oil, gas, mining, power and infrastructure sectors. Key customers include most of the world’s largest oil and gas, mining, chemical and petrochemical companies. The Company provides engineering services across the entire project lifecycle, i.e. planning, development, operations and ultimately project de-commissioning.
Key Fundamental Drivers
Market Concerns Around Stalling Growth Appear Tenuous
In the 2H24 period to the end of February 2024, backlog growth was largely flat. The perceived decline in backlog growth relative to 1H24 has been source of market concern. Contract wins over this period of $3.1b exceeded $2.0b backlog delivered, with the deficit ($1.1b) a function of either cancellations or deferrals in the scope of work undertaken. However, two points are worth noting here:
i. Industry feedback indicates that the latter is being driven by deferrals, as opposed to cancellations. The deferrals are stemming from a shift away from green fuels/ hydrogen work in Europe back towards traditional work. There has been evidence of some shift in capital flows among traditional, transitional, and sustainability areas. However, overall CAPEX by major oil & gas companies (to which WOR is highly leveraged) is still being spent globally – and WOR captures this across its group. Although WOR is seeing a slight shift back toward traditional, margins remain broadly similar across traditional and sustainability areas.
ii. Three contract wins have been disclosed to the ASX since April, suggesting that any slowdown in activity has likely been temporary. In context, the rate of growth in the gross margin profile for the factored sales pipeline has been accelerating, implying that demand for WOR’s services remain high.
Upside Potential to Medium-Term Margin Expectations
A key factor supporting EBITA margin growth in recent years is that gross profit margin has been increasing in both backlog and factored sales pipeline over last two years. The gross profit margin for the pipeline is greater than that for backlog.
At a Strategy Update in May, WOR re-iterated guidance for underlying EBITA margin to increase to 7.5-8.0% in FY24 (from 5.8% in FY23). The expansion in EBITA margin results from higher-margin work is entering its factored sales pipeline, and converting to improved backlog margins. Other factors supporting margin improvement include improvement in rates through WOR’s backlog, along with improved staff utilisation.
Over the medium term, there is upside potential to consensus margin forecasts from improved cost-out and productivity from AI/automation, Technology Solutions, digitisation and consulting services growth. WOR is also looking to change pricing model to capture share of value created (as opposed to person hours) and has successfully implemented value-sharing with its Global Integrated Delivery model based in India.
Putting into Perspective Delays in CP2 Project
By way of background, in May 2023, WOR entered into an EPC contract for Phase 1 of Venture Global’s Calcasieu Pass 2 (CP2) liquefied natural gas (LNG) terminal in Louisiana, US. Under the contract, Worley will provide full EPC execution, including engineering, procurement, direct-hire construction (EPC), commissioning and start up for Phase 1 of CP2, a low-carbon LNG terminal.
The project is still awaiting approval from the US Federal Energy Regulatory Commission (FERC), which could facilitate a Final Investment Decision (FID). There is potential upside to FY25 earnings in the event that FERC approval is granted in 1H25 (i.e. prior to the US elections) which would enable FID irrespective of export authorisation from the Department of Energy.
While the delay in FID continues to weigh on investor sentiment, several factors are worth noting:
i. In FY24, the impact from the delay in FID has been mostly offset by accelerated engineering works.
ii. WOR has enough engineering work on Venture Global contracts to carry through to end of 1H25.
iii. There are other large-scale engineering projects set to move into the award phase over the next few years. A more permanent shift to reimbursable EPC contract pricing structures in the LNG market also aligns with WOR’s strategy and opens up a new market for the Company. In particular, there is an estimated US$145b in projects scheduled for FID over the next few years.
Fundamental View
While the shares have recovered strongly since our recent report, WOR is a stock worth considering. The current multiple (16.5x) remains undemanding in the context of an EPS growth profile of 19% over FY24-26 on a CAGR basis. Further, there is upside potential to consensus margin estimates; forward revenue indicators (factored sales pipeline; contract wins) remain solid; and the balance sheet is conservatively geared.
Charting View
The past several weeks saw Worley slip under its uptrend line. However, it then bounced off support near $14. The stock also triggered a buy signal on the daily RSI (not shown). We are likely to continue seeing a move higher here from WOR and it should go on and retest the underneath of that downtrend line above $15. WOR is therefore a tentative buy here and break above this line would be the next buy signal.
Michael Gable is managing director of Fairmont Equities.
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