We recently researched Worley (ASX:WOR) after the Company released results for the 12 months to 30 June 2023 (FY23). The key debate around the stock’s investment attraction is the extent to which the Company can monetise the shift towards sustainability-related investments and projects.
Positive market sentiment towards WOR often captures this potential upside. However, on occasion, negative sentiment regarding the macro outlook can lead to periods of price weakness. With this in mind, are the shares are fully valued, or starting to look attractive?
Worley is a provider of global engineering, advisory and project management services to the oil, gas, mining, power and infrastructure sectors. The Company provides engineering services across the entire project lifecycle. Key customers include most of the world’s largest oil and gas, mining, chemical and petrochemical companies.
Key Fundamental Drivers
Multiple Levers Support Strong Revenue Growth Outlook
The revenue growth outlook is supported by the Company’s expectations for low double-digit growth in the capital expenditure (CAPEX) plans of its key customers. In particular, CAPEX for WOR’s key customers is growing at a faster rate compared with the total Energy, Chemicals and Resources (ECR) market. This is due to the Company’s focus on sustainability-related investment.
CAPEX intentions from global Oil & Gas majors have recovered to pre-COVID levels albeit still down from record levels reached in early 2010’s. These CAPEX plans include large sums (in the billions per annum) for energy transition projects. WOR is well-placed to capitalise on energy transition work, having developed expertise in these fields through targeted investment over the last three years.
Aside from this, the Company’s revenue is becoming increasingly skewed towards sustainability projects. Work from sustainability projects now accounts for 41% of aggregate revenue, a +6% increase on FY22. The Company maintains its target to derive 75% of revenue from sustainability in FY26.
The Company is investing $100m over FY22-24 to support growth in high growth/margin sustainability markets. These strategic investments should help WOR to achieve its FY26 target for 75% of aggregated revenues to be sourced from sustainability-related work. Within the end markets identified, WOR forecasts an addressable market of over $180b. These include three key areas – Battery Materials, Carbon Capture, Utilisation & Storage (CCUS) and Low-Carbon Hydrogen.
Margin Expansion Expected Over Medium Term
Margins for both WOR and its Engineering Services peers have strengthened. This is due to stronger pricing power because of increasingly complex projects and tightening demand/supply for engineering services.
WOR has upgraded its expectations for underlying EBITA margin in FY24. From prior guidance of 7.5%, the Company now expects a range between 7.5% and 8.0% in FY24. This represents a 100-150 basis points increase on FY23. The upgraded guidance is supported by higher margins in factored sales pipeline and backlog.
WOR is targeting further margin improvement in FY25 & FY26. This is because the Company remains well positioned to convert higher-margin work in the factored sales pipeline and backlog. Further, procurement volumes are expected to substantially lift in FY24 (vs FY23), which is a function of three factors. Firstly, the growth trend in factored sales pipeline together. Secondly, WOR has a high contract win rate and increased growth in gross profit margin. Finally, there is a strong correlation between the conversion of factored sales pipeline into bookings then subsequently backlog. As the Company deliver on its backlog, this is being replaced by new contract wins at higher margins.
A key risk regarding the extent of margin expansion over the short term is the growth in labour costs. These have historically been linked to revenue growth. To this end, the Company expects that revenue should be able to grow beyond headcount growth. Staff utilisation remains above target (87%+ in FY23), with the Company considered to be managing labour pressures well.
Reduced Gearing to Allow Pursuit of Growth Opportunities
WOR has a solid balance sheet, with gearing of 2.2x (on a net debt to EBITDA basis) as at 30 June 2023. The gearing level is above the top end of the target range of 1.5x – 2.0x. However, it remains with covenants and provides scope for further Merger & Acquisition (M&A) opportunities.
M&A opportunities are unlikely to be pursued in the near term. This is because acquisition multiples appear expensive. Further, any acquisitions would likely be limited to small-sized companies given the current gearing level. Due to stronger cashflows, the Company is expecting gearing to decline to below the top end of the gearing range. Upon achieving this, the Company would be in a better position to pursue organic growth opportunities.
At current levels, Worley is trading on a 1-year forward P/E multiple of ~20x, which is slightly above the 2-year average of ~18x. The shares are also trading above global peers and also above engineering services peers. This reflects WOR’s elevated earnings growth opportunity from sustainability work and the potential for further contract wins.
Notwithstanding these factors, the current multiple does not appear to be stretched in the context of an EPS growth profile of ~17% over FY23-26 on a CAGR basis. There is potential for a further re-rating given that consensus estimates are presently not factoring in either Company EBITA margin guidance for FY24, or any expansion in EBITA margin in FY25/26. This is despite the Company being well positioned to deliver on its backlog and replace this with new contract wins at higher margins. Also, earnings are highly leveraged to the rapid increase in global energy investment and decarbonisation projects.
A potential near-term catalyst is the upcoming Final Investment Decision on the Venture Global’s Calcasieu Pass 2 LNG export facility, which is expected later this calendar year.
We have looked at this chart on a few occasions during the year and noted that a break above $15.50 would lead to a rally. It has had a couple of false starts, but the breakout in May has finally seen some follow through. However, the stock has been range-bound in the past several weeks with some clear price rejection above $17.50. A break back above $17.50 would be a clear signal that WOR is on the way back up again.
Michael Gable is managing director of Fairmont Equities.
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