BUY HOLD SELL – Worley (ASX: WOR)
Worley (WOR) has come a long way since its start in 1893, an engineering company specializing in steam power. Its aim now is to deliver a more sustainable world and it is structuring itself to benefit from the current energy transition. It provides engineering, procurement and construction expertise to the upstream, midstream, chemicals, power, and mining and minerals sectors.
In 2018, Worley Parsons changed its name and bought Jacobs Engineering for $4.55bn. Management described the deal as an ‘opportunity enhancer’. One of the important outcomes of the deal was that it reduced the reliance on hydrocarbons like coal and oil to 52% from 75%. It is clear Worley still has strong indirect exposure to the energy sector but unlike Woodside (WDS) and Santos (STO) which have incredibly capital-intensive businesses given the cost of oil rigs and pipelines, Worley is a far more nimble business without the need for large capex to generate revenue. The need for hydrocarbons in the global energy narrative isn't likely to disappear in the near future. The global oil and gas industry requires more than $600bn of investment annually until 2030 to keep pace with the rising demand. Big underinvestment and the energy crisis caused by the Ukraine war have aggravated the supply-demand imbalance. It has also placed a bigger emphasis on the need for cleaner sources of energy. To provide some perspective on the ‘energy transition’, Bloomberg estimates that clean energy investments from 2022 to 2025 need to annually triple the current 2021 spend, and then double from 2026 – 2030 to meet net-zero targets. Management sits comfortably in both segments that require that substantial investment. While Worley still derives a large portion of its revenue from what it labels ‘traditional energy’ sectors its sales pipeline continues to see improvement in the number of sustainability-based projects. Management now targeting revenue to be 75% sustainability-related in the next 5 years as it turns around preferences. The other encouraging element is sustainability-related projects have also been delivering better margins. Worley’s investor day last week highlighted expectations for improved earnings to finish the second half of the year. The business remains on track to deliver $375m in operational savings by June next year. Growth in the order backlog and increased headcount are other positive comments. The increase in headcount can be viewed as a strong sign the company is entering a growth stage of the cycle. You wouldn’t be hiring a bunch of new workers if you had doubts about the outlook for your business.
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- ROE is not what you’d label as impressive at 5.2%. Its peer, Monadelphous (MND), sits on 12.4% so WOR is a bit behind.
- Worley sits on a PE multiple of 26.3x which is expected to fall in the next few years. Monadelphous sits on 23.3x.
- A gross yield of 3.2% is OK but below the market average of ~4.5%. Monadelphous has a gross yield of 5.1%.
What are the tailwinds?
- Clean energy investment is projected to rapidly grow to meet net-zero targets.
- Renewed focus on energy security and independence is accelerating low carbon energy investment.
- Traditional and sustainable energy sectors are growing across all regions. A robust pipeline of work affirms that trend.
- Policy support growing significantly across Canada, Europe and the United States. Since 2020, governments have committed US$4b specifically for Direct Air Capture which is a fancy way of saying carbon capture and storage.
- The chemicals market remains on track to experience one of the highest levels of material demand growth of all industrial sectors. The traditional chemicals segment makes up 29% of revenue with the sustainable chemicals segment pushing that revenue number above 30%.
What are the risks?
- A significant drop in oil prices would be expected to lead to a major cut in capital expenditure which in turn would put a cap on new projects in the oil and gas sector. The hydrocarbons sector comprises over 52% of Worley's current operating revenue.
- Slowing global growth and the potential for black swan events particularly in China to crimp energy demand lingering concerns.