Petrofac Limited (PFC) Earnings Call Transcript & Summary

Hello, and welcome to the Petrofac 2020 Half Year Results Conference Call. My name is Judy, and I'll be the coordinator for today's event. Please note that this call is being recorded. [Operator Instructions] I would now hand you over to your host, Ayman Asfari, to begin today's conference. Thank you.

Good morning, and welcome to our half year results presentation for 2010. I'm joined today by Al Cochran, Chief Financial Officer. Al will shortly take you through our financial results. But first, I'll summarize the highlights. The first half of 2020 has been defined by the dual shock of COVID-19 and the collapse in oil prices, which have had a material impact on our operation and financial performance and new orders. Nonetheless, we've acted swiftly to mitigate the impact of these headwinds, protecting the health and well-being of our people, suppliers and communities, structurally reducing costs and conserving cash. At the same time, we've been careful to preserve our core capability and continued to invest in enablers for the future, such as digitalization and our energy transition ambitions. All this has underpinned 2 imperatives: continued safe delivery for our clients in highly challenging circumstances and thanks to the resilience and innovation of our people; and maintaining and future proofing our cost competitiveness. I have no doubt these measures will continue not only to protect us now but also for the long term and best position us for the inevitable recovery when it occurs. Looking beyond current conditions, the 3 themes of energy transition, sustainability and digitalization will define our ability to support our clients in meeting the world's evolving energy needs and to create value for all our stakeholders. This is why these have been and will continue to be key components of our consistent strategy of best-in-class delivery, positioning for growth and enhancing returns. I'll now briefly touch on one of these key themes, sustainability. Our evolving sustainability program encompasses all aspects of ESG relevant to Petrofac and our stakeholders. Today, we're advancing specific areas. Building on our 54% emissions reduction since 2015, we're announcing a new commitment to reaching net zero in Scope 1 and 2 emissions by 2030. Our Reduce, Transform, Enable Strategy will focus on 3 areas: reducing our own emissions; embracing a new decarbonization technology; and supporting clients, partners and suppliers and their lower carbon ambitions. Whilst we have 18 nationalities in Petrofac and a strong representation of women at Board and junior levels, we are today signaling our commitment to an ambition of 30% women in senior roles by 2030 with progressive milestone targets in 2021 and 2025. The continued progress in our ethical culture in recent years is underpinned by a robust compliance regime. This continues to be independently benchmarked against the highest international standards as part of our commitment to best-in-class compliance. We will also increase our climate-related financial disclosures through the Task Force on Climate-related Financial Disclosures program as a further signal of our commitment in this area. With that, I will now hand over to Al to talk about our financial performance in the first half.

Thank you, Ayman, and good morning, everyone. As expected, first half results in 2020 have been impacted by both COVID-19 and lower oil prices. However, swift management action has significantly mitigated the impact of unprecedented market conditions by reducing both costs and conserving cash, resulting in a first half net profit of $21 million and net debt of $29 million. At this time, our priorities are clear: firstly, reduce costs to improve profitability and competitiveness; secondly, conserve cash to maintain a strong balance sheet; and thirdly, rebuild our $6.2 billion order book. Accordingly, the Board has decided to continue to suspend dividend payments at the current time and does not expect to resume them until there is a sustained recovery in new order intake. So let's look at the half year results in a little more detail. At a group level, revenue of $2.1 billion reflected declines in revenue in all our operating segments. EBITDA and net profit excluding exceptional items will also lower year-on-year, with higher project costs, changes in mix and the nonrecurring Jazan commercial settlement all reducing net margin. These headwinds were partly offset by overhead cost savings and a lower tax expense. As a consequence, diluted earnings per share fell to $0.062. Reported earnings declined to a net loss of $78 million after recognizing exceptional items of $99 million in the period. The majority of these were incurred in our IES portfolio, notably, an impairment of the carrying amount of PM304, reflecting the decline in oil prices, fair value remeasurements of the carrying amount of contingent consideration for both Pánuco and the Greater Stella Area and a modest exceptional loss associated with the early settlement of deferred consideration for GSA. Overall, the cash impact of exceptional items was only $11 million. At a divisional level, adverse market conditions had the greatest impact on Engineering & Construction. Revenue fell 28% to $1.6 billion in the first half, largely reflecting COVID-related project delays, which will be recovered in future periods. As you can see from the chart, net margin also decreased to 2.1% driven by COVID-related cost increases, changes in project mix and the nonrecurring Jazan settlement. Consequently, net profit fell 76% to $35 million. As I commented at our recent trading update, the underlying impact of current headwinds on the E&C margins, excluding this nonrecurring settlement, was approximately 1%, following the action we took to reduce project support costs and overheads in the period. Looking forward, we expect to burn $1.3 billion of E&C's order backlog in the second half of 2020 based on an assumption that COVID-related restrictions continue to ease. Our reimbursable Engineering & Production Services business has proved more resilient in the downturn, benefiting from strong order intake of 1.5x book-to-bill. Revenue fell by a modest 5% to $426 million, with COVID-related restrictions resulting in the partial demanning of our North Sea operations and the temporary closure of our training centers worldwide. Net margins decreased to 4%, reflecting the expected decline in brownfield project margins, the change in business mix and the lower contribution from associates which were reclassified from IES at the beginning of this year. Once again, overhead cost savings and a lower tax expense improved net margin. As a result, net profit declined 53% to $17 million. Looking forward, we expect EPS revenue to be broadly flat in 2020 year-on-year, benefiting from the increase in order backlog in the first half. Finally, financial performance in our Integrated Energy Services division was impacted by the sharp fall in commodity prices in the second quarter, with a 46% year-on-year decline in average realized oil prices materially reducing both revenue and EBITDA. However, this masks good underlying operational performance, which delivered higher equity production at materially lower OpEx and overhead costs. Performance in the period also benefited from lower depreciation, lower tax and lower minorities, resulting in IES posting a small net loss of $10 million in the first half, as expected. Looking forward, we expect the sale of our remaining interest in Mexico to complete in the second half of 2020, leaving PM304 the sole upstream asset in our portfolio. At current oil prices, IES will continue to generate small losses. As you will have noted, a recurring theme in our results is a positive impact of cost-cutting measures we have taken to respond to COVID-19. Overall, we are on track to deliver $125 million of gross savings in 2020, higher than originally announced and up to $200 million in 2021. Do please remember that in accordance with IFRS 15, the benefit of project support cost savings are spread over the life of the relevant contract. The majority of these savings are structural in nature, such as the permanent rebasing of salaries, reducing headcount and eliminating wastage. We have preserved core capability and believe that continued investment in digital, automation and offshoring will increase productivity and structurally reduce costs further in the future. Finally, it's worth noting that payback is quick, with a total cash cost of $50 million being less than half the targeted level of savings this year. Moving to the balance sheet. Net working capital increased in the first half of 2020, reflecting an expansion in both DSO and DPO. The 8-day increase in days payable outstanding was driven largely by a rise in trade payables, whilst the increase in days sales outstanding reflects an increase in billable WIP as clients took longer to approve invoices and an increase in trade receivables as they took longer to make payments. Both of these are evidence of clients managing their cash flow in tighter market conditions. Please note that this is a timing issue and we are not concerned about our clients' ability to pay. I'd also like to remind you that working capital and, by extension, operating cash flow is sensitive to the timing of commercial settlements this year. Furthermore, market conditions are putting strain on clients' cash flow. So whilst we continue to carefully manage working capital, it would be prudent to assume a further modest expansion in working capital in the second half. In cash terms, the decline in EBITDA and the working capital outflow of $57 million depressed cash conversion despite lower tax payments. However, the actions we took to conserve cash did significantly improve net cash flow, reducing CapEx by 50%, accelerating the receipt of deferred consideration from Greater Stella and suspending the dividend. Collectively, these measures resulted in a modest free cash outflow of $13 million and net debt of $29 million. We also closed the half year with $1.2 billion of liquidity and with significant covenant headroom after retiring $275 million of debt in the period. We remain committed to capital discipline, conserving cash and maintaining a strong balance sheet. We also continue to target net cash, although the outcome at the end of this year will largely be determined by client behaviors and the timing of commercial settlements. At the beginning of this year, before the advent of COVID-19 and the fall in oil prices, I commented that we would continue to pull all the levers within our control to improve our cost position and protect the balance sheet. Market conditions may have changed, but our strategy and determination to maximize cash flow and enhance returns has not. In the last few years, this strategy has transitioned Petrofac back into a more cash-generative, capital-light business capable of generating higher returns. In the last 3 months, in response to marketing conditions that no one foresaw, we've taken swift and decisive action to structurally reduce costs and conserve cash whilst protecting core capability and our investment in digital. This strategy and these actions best position the business for recovery and a subsequent return to growth. With that, I'll hand back to Ayman.

Thank you, Al. I've experienced many downturns in my 40 years in this industry but never anything quite like this. As Al outlined, our work over the past 3 years in transforming into a capital-light business put us in a much better shape to weather this downturn than we might have been. While much of the focus this year has been on the immediate priorities to safeguard the business, I want to reiterate that, going forward, we remain committed to the consistent strategy that has served us very well. This strategy, combined with swift management action and continued investment in the future, positions us to weather the near term and to capitalize on the inevitable recovery. And now I'll take you through why. The measures we have taken to combat the challenges presented by COVID-19 have allowed us to continue to deliver safely for E&C clients, from stringent site health controls and virtual work environments to ensuring supply chain continuity and embracing new technologies at pace to problem solve. And as you will see from the chart, there's now a slowly improving picture as travel restrictions ease, lockdowns lift and factories reopen. Engineering has been remarkably resilient through an almost seamless transition to virtual working. Procurement progress is improving, aided by technology innovations. Even in Construction, which is most impacted by COVID-related disruptions, we are seeing signs of improvement. Our clients have been very pleased with our execution, a particular highlight being mechanical completion of BP's Ghazeer plant in Oman that was delivered within budget, ahead of schedule and LTI free with more than 19 million man-hours executed. Similar efforts in EPS have allowed projects activity to remain resilient. A proud milestone was the Iraq Crude Oil Export Expansion Project's achievement of more than 2 million barrels exported in a day in April despite nationwide lockdown on an asset we have operated for almost 7 years. Operations maintained safe round-the-clock delivery with reduced crews using our new PetrofacGo app to communicate the latest health and travel information. Since June, disruption has eased and we have begun to see increasing numbers of North Sea mobilizations. Turning now to new order intake in the first half. March's decline in oil prices led to one of the lowest-ever levels of awarded bids in our industry in the first half. Whilst we've seen no cancellations, delays and deferrals in EPC awards are becoming a common theme. And you'll see in the next slide how this influences next year's bidding pipeline. However, I would first throw you to some positives. Spending on renewable energy has remained resilient. And we were delighted to secure an award to construct 2 HVAC substations for Scotland's Seagreen offshore wind project. Critically, we remain competitive. Our issue has been the level of awards in the first half, not our ability to win them, as evidenced by our E&C win rate of 26%, in line with our historic average and a pleasing book-to-bill of 1.5x in EPS. Turning now to our group bidding pipeline. Our $46 billion pipeline reflects the low level of awards and deferrals we have seen recently. In light of this trend, we prudently anticipate the majority of 2020 tenders will be delayed into 2021. And whilst there's always the potential for some slippage beyond 2021 to 2022 given current uncertainties, we do believe that at least $25 billion of work will be awarded by the end of 2021. Turning now to the geographic and market composition of our pipeline. Our pipeline comprises an attractive and balanced geographic and market mix. We expect our core markets in the Middle East to rebound first and remain resilient over the long term due to low production costs. The remaining half comprises tenders in growth countries beyond our core markets where we continue to target geographic diversification. Almost 60% of the pipeline is skewed to energy transition spending, such as gas production, refinery upgrades, decommissioning of aging oil infrastructure and offshore wind, all of which play to our core capabilities and where we have strong credentials and a proven track record. Looking beyond the 18-month view, we continue to anticipate long-term spending growth in our core business as markets recover. While client oil and gas CapEx has sharply contracted, we believe we are currently at the bottom of the cycle and recovery will follow. Furthermore, global demand for gas as a transition fuel is expected to grow over the next decade. Therefore, we see significant continued investment in this area for the foreseeable future. In new energies, spending on offshore wind has been resilient in the first half of the year, with rapid growth in capacity expected over the next 2 decades. We also expect growth in spending on energy transition-dependent technologies such as carbon capture, utilization and storage. Whilst a very small market today, huge growth in CCUS capacity will be required if the world is to meet the Paris Agreement targets, although this will be contingent on support from the government policy. I'll now highlight why we are well placed to compete in these markets. We have the core capabilities, track record and competitive differentiation for continued success in key energy transition markets. We have proven we can add value in offshore wind transmission systems. We are replicating this approach with our early move into carbon capture and storage, which represents a small market today but has high potential and plays to our skills in engineering, gas handling expertise, brownfield EPC skills to modify existing infrastructure and wells capability. Our leading capability in well plug and abandonment and decommissioning enables us to capitalize on this growing market over the next decade. So to summarize. As expected, the first half of the year has been defined by the dual shock of COVID-19 and the falling oil prices. Our transition back to a capital-light business since 2017 and the swift management response have mitigated the impact. We are positioning for success now by continuing to deliver safely for our clients in challenging conditions; by enhancing our competitive cost structure and strengthening our balance sheet; and by retaining our core capability and investing in digital; and by replenishing our order book from an attractive pipeline. I'm confident these measures will position us best for when the markets recover and for long-term growth through the energy transition. With that, I'll now hand back to the operator for any questions that you may have. Thank you.

[Operator Instructions] The first question is coming from the line of Amy Wong from UBS.

A couple of questions from me. The first one relates to your bidding pipeline. You've got some labels there with transition field activities, new energies and traditional. Saw a slight departure in language compared to how you used to label your opportunities in upstream oil and gas, refining petchems and renewables. So just curious into just understanding how you came up with those titles. What kind -- how would we swap some of the kind of buckets of work from the old way you used to talk about your bidding pipeline to the new way you are talking about your bidding pipeline? And does it indicate even like a more strategic shift in your business? That's my first question.

Amy, we are -- I think the way that we are identifying the pipeline, we're talking about the core markets and the growth geographies and we also identify the amount of business that's coming from the new energies. Now the new energies is the low carbon, the zero carbon as well as, for the time being, we've got the activities in natural gas and some of the refining upgrade to improve the quality of the products to reduce emissions as part of the transition fuel. As we get to the end of the year, we will be talking about what we see as our targets in the new energies, which is zero carbon emissions, offshore wind, carbon capture and we're looking at concentrated solar. We're looking at areas of new energy as well as defining where we see our business in the transition fuels, which is effectively the natural gas. But most of our business going forward is going to be between natural gas and -- I mean we've been big in natural gas for a long time, but in gas as well as the new energies. But we're looking at increasing the proportion of new energy as part of the overall portfolio. For now, it's principally offshore wind and it's around 5%, 6%, 7% of our business. We're trying to take this to a higher percentage of work. And we're looking at new areas. Some of the contracts we have recently entered into for doing engineering, for carbon capture in the U.K. is quite exciting. I think this is a big area particularly when combined with hydrogen as well. So these are some of the areas that we will be talking about more as it comes to the end-of-year results.

And second question is probably more for Al. Just looking at your -- good to see some cash generation in June. But thinking -- and you gave some guidance in terms of expecting a moderate working capital outflow in the second half. Could you talk a bit more about kind of the moving parts in the working capital in the second half? And other -- are there any other kind of big parts in cash flow we should expect to see?

Sure. So I'd perhaps just work my way down the cash flow statement to make it easy. Second half, we do expect another modest outflow in working capital. That's entirely consistent with the guidance I gave at the beginning of the year. For CapEx, we announced our target to reduce it by at least 40%. You saw we modestly exceeded that target in the first half. But broadly speaking, over the full year, I would expect at least 40% reduction. Cash, effective tax this year I expect to be broadly spread over the year. Second half cash interest should be lower as average gross debt levels reduce. And finally, the other thing just for you to remember is divestments. We are expecting to close the Mexico sale in the second half. That's $88 million of firm cash proceeds plus any working capital adjustments. And as you might recall, we have been investing in that asset over the last period, so we would expect a slight positive working capital adjustment.

And the next question is coming from the line of Sahar Islam from Goldman Sachs.

On some of the key awards we should expect in the next 12 months, particularly the ADNOC awards, there's been some industry press that some of the tendering processes are still going -- ongoing for projects like Umm Shaif. Could you give us a bit of an idea of whether you expect anything to come this year or whether we should think about all of these now 2021 awards? And then secondly, on some of the new energy targets, do you expect to grow that new energies capabilities organically or could you do some small bolt-on there as well?

Thank you. Just on the first question in terms of awards, the client's stated intentions is that those awards will take place in Q4 this year. We are bidding Umm Shaif. We're bidding Dalma again. It's out to bid, so we're bidding it. And the bids are going in soon, I think, in the next month or so. And we have a bit outstanding for Upper Zakum, which is another development. And we're bidding about $10 billion, $12 billion for Saudi gas development for Hail and Ghasha. And we're involved in the project lightning, which is to deliver power to the offshore islands, which is also a very major proposal. We probably have about, I don't know, $12 billion, $13 billion, $14 billion worth of bids. This is our share in Abu Dhabi. I mean the client's stated intention is that some of those -- or most of those will be awarded in Q4. But to be candid with you, judging by the history, we think many of them will slip into Q1 next year. We are being prudent in our planning. We would be very pleasantly surprised -- or not pleasantly surprised, we'd love to see some awards come in the Q4. But we have been prudent in our planning and we're making the assumption that most of those will slip into Q1 next year. But I wouldn't be surprised if half the awards take place later this year if the client sticks to their current [ schedule ]. Now on the question of new energies, what we're trying to do, to be candid, is to look at how we leverage our current skills that we have inside the business to tap into this new market. So for the time being, it's about how do we maximize our position in offshore wind, how do we do more. We've been involved mainly with the transmission with the HVAC and HVDC business. We're looking -- do we -- can we do more in offshore wind with the current capability. And we're looking now at the CCUS. A big part of that is really using the current infrastructure, particularly CCUS in the U.K., to reverse flow and to inject CO2 in depleted reservoirs. We are -- we have most of the capability to do this work. Some of these projects would probably end up being lump sum or some kind of a combination of lump-sum reimbursable. We have looked at technologies to -- but we think that there is a lot more we can do by just leveraging the current skills that we have inside the business to do more in this space. This is a piece of work that's ongoing right now inside the group. And I think with the end-of-year results, we'll be able to articulate very clearly the areas where we want to grow our business in new energies and how we will get there and what percentage of our overall revenue it will be in the future. There's a lot of energy inside the group to do more in that area. And we will show how our overall revenue over time will increase in that space.

[Operator Instructions] The next question is coming from the line of Mark Wilson from Jefferies.

Two questions, please, to start. The first is that your backlog doesn't include -- sorry, your bidding pipeline doesn't include Saudi and Iraq. So I guess, Ayman, what would it take to be included back in those markets? And then secondly, Alastair, if I could ask, what is the breakdown of the E&C backlog and EPS backlog by the year, please?

You're absolutely right. Our backlog doesn't include Saudi and Iraq. Again, this is out of prudence. It's not because we do not believe we will be bidding in Saudi and Iraq. To give you an idea, in Iraq, we've been operating an infrastructure in Fao Terminal for the last 10 years. And we've had an extension last year for 12 months after the publicity around Iraq. And we are hopeful that we will continue to provide that service because we've been doing really a fantastic job. We didn't have a day of downtime. And 2 million barrels of Iraqi crude is being exported through that terminal. So the Iraqis rely on us very heavily. I have said before that I'm absolutely confident that as soon as the SFO matter is resolved, we will be back in no time. I'm hopeful that we will be returning and we'll be bidding in those 2 countries before the SFO issue is resolved. But really, it's up to the clients to decide this. But we have a very constructive engagement with both the Saudis as well as the Iraqis. I talk to them regularly, both to people in the industry as well as the client, Aramco and BOC, Basra Oil Company. And we have a very good relationship. You can imagine we're doing everything we can to allay any concerns that they have and hopefully be back at bidding. But again, out of prudence, for the time being, we have shown a pipeline which doesn't include these markets. If these markets were to be included, it would probably add about $10 billion to the pipeline between now and the end of '21.

Okay. And yes, Alastair, on the breakdown of the current backlog, please?

So of the $4.3 billion in E&C backlog, $1.3 billion is scheduled to be executed in the second half of this year, $2.3 billion in 2021 and the balance thereafter. And in the $1.9 billion of EPS backlog, $0.4 billion is scheduled for delivery in H2 this year, $0.7 billion in 2021, and the balance thereafter. It's probably also just worth noting that this is our secured backlog in E&C. Obviously, this current year would exclude any additional variation orders that we secure. And in EPS, of course, there's still the opportunity that new wins could contribute to 2020 revenues in the second half.

Right. Okay. And then also, if I may, just to check on the margin guidance in E&C, you said how, excluding Jazan, there's been a 1% COVID-related impact. And when you speak to that, you're speaking to the 4.5 midterm level that you'd be looking to get back to once COVID has moved on. Is that correct?

Well, Mark, we haven't provided E&C guidance on margins. We have provided revenue guidance obviously, but given the uncertainty, we haven't provided guidance on E&C margins. What we have said though, of course, is in the first half, if you exclude that nonrecurring Jazan commercial settlement, the overall impact of COVID-19 cost increases, the general pressure we're seeing because of the environment, offset by cost savings, was a 1% decline. We would expect that to go forward. So if you do some maths based on previous guidance and what we said in the first half, I think you should get in roughly the right place.

And the next question is coming from the line of Amy Sergeant from Morgan Stanley.

I just had a couple of questions. So first, sort of related to the comments on the rise in days of sales outstanding and just any color you can provide on how that's shaping up so far in the second half and if you're seeing sort of any improvement in that kind of processing of invoices and payments. And then also, if you could just remind us if there's any more sort of commercial settlements we should be looking out for in the second half and any color around those, that would be great.