Petrofac Limited (PFC) Earnings Call Transcript & Summary

Welcome to the Petrofac analyst and investor call. [Operator Instructions] Just to remind you, this conference call is being recorded. Today, I am pleased to present Alastair Cochran, CFO. Please begin your meeting.

Good morning, everyone. Thank you for joining our regular pre-close trading update call. I will make some brief comments on our statement before opening the line for questions. Overall, the group is trading in line with expectations for 2020 as we approach the year-end. Financial performance in the second half has continued to be impacted by COVID-19. However, we have continued to deliver projects for clients throughout this difficult environment, whilst doing everything within our control to protect the health and well-being of our employees, subcontractors and communities. Furthermore, the swift and decisive actions we took, to protect the long-term health of our business in Q2 and reduce overhead costs by $125 million this year, have protected margins and cash flow. As a result, management continues to expect to report lower group revenue of approximately $4 billion and materially lower profitability in 2020. In Engineering & Construction, full year revenues are expected to be around $3 billion, driven by a decline in project activity, COVID-19-related project delays and lower variation orders. Swift management action to reduce costs and lower tax has partly mitigated the decline in full year margin caused by COVID-19-related cost increases, changes in project mix and the recognition of losses on a small number of contracts. Engineering & Production Services meanwhile has benefited from strong order intake and lower overhead costs this year, which has mitigated the impact of weaker market conditions. Consequently, 2020 full year revenue is expected to be broadly comparable to last year, whilst the expected year-on-year decline in contract margins and contribution from associates has been partly offset by cost reductions and lower tax. Full year revenue in IES in 2020, on the other hand, is expected to be materially lower than last year, principally reflecting the sharp fall in commodity prices and to a lesser extent, lower equity production and lower cost recovery following the sale of our Mexican interest on the 3rd of November. Reductions in operating and overhead costs as well as lower interest, tax and depreciation have partly mitigated the impact of lower revenue, but we continue to expect to report a net loss in 2020. Looking forward, our strategic priorities are clear. Despite the uncertain near-term economic outlook, we are focused on conserving cash, cutting costs, rebuilding backlog and delivering operational excellence. As part of this, we have today announced that we are increasing our cost savings target for 2021 by 25% to approximately $250 million. This will seek to protect the business from lower revenues and ongoing pressures on margins whilst preserving core capability. Furthermore, these measures are creating a leaner, more competitive business, which will position us well for opportunities when the market recovers. Lower oil prices have resulted in delays in awards of new projects that have affected the entire industry this year. Looking forward, it remains unclear how long business activity in our industry will be impacted by current market conditions. Notwithstanding this, we have won $1.4 billion of new orders this year-to-date, of which some 25% were in renewable energy projects. And we have a large pipeline of around $42 billion of bids scheduled for award by the end of 2021. Finally, management's actions have protected our balance sheet and liquidity. At the end of November, net debt was $272 million and liquidity was approximately $1 billion. Year-to-date, we have secured $250 million in additional liquidity, and we are in discussions with lenders to complete the exercise to pre-fund 2021 maturity. Cost-saving initiatives, the suspension of dividends and reduction in CapEx have conserved at least $275 million in 2020. In addition, we received $140 million in gross proceeds on the sale of noncore assets this year. All these actions have strengthened the balance sheet and reduced capital intensity. So to conclude, the group is trading in line with expectations as we approach the year-end. Our strategic priorities in the current difficult market environment are clear: to conserve cash, cut costs, rebuild the backlog, and deliver operational excellence. These priorities, combined with a large bidding pipeline and our competitive position in attractive markets, position us well for opportunities when the market recovers. With that, I'd like to open the line for questions.

[Operator Instructions] Our first question is from the line of David Farrell from Crédit Suisse.

Can I just ask a question about kind of the refinancing. I think kind of the tone of your comment is changed slightly in terms of prefunding 2021 maturities. Does this mean you're -- are we looking more at bonds now rather than refinancing the RCF? And then can I just ask, to what degree is lack -- still lack of uncertainty around FFO financial penalty having an impact here in terms of finalizing the negotiations?

Thank you, David. I think you're trying to read too much into this, to be perfectly honest with you. So I always said that we would seek to prefund our 2021 maturities, which is essentially the RCF this year. We are in discussion with lenders to complete that exercise. It is focused on conventional sources of debt funding. And I've always said that we'll be seeking to term out those maturities, so that we provide headroom for at least a few years. We have secured $203 million in additional liquidity this year-to-date. So we have been making progress, and frankly we are making good progress. So inevitably these things are subject to final lender approvals. That timetable is not totally in our control. But throughout the period where we have maintained liquidity significantly ahead of our target throughout the year-end, we do indeed retain a strong balance sheet, strong credit metrics, and substantial covenant headroom. So look, we'll -- inevitably, I'm sure you'll all be very interested to hear when we have completed. We'll announce that in due course for the time being, and I'm afraid you have to be patient.

Okay. And can I just have a follow-up? Obviously, you've had the COVID-19-related costs below the line -- sorry, above the line, which is good. But could you quantify what they are going to be for 2020?

2020 or '21? Sorry, just to be clear there.

2020, so what you've incurred this year in terms of COVID-19-related costs?

Okay. So if you look at our 2020 EPS -- EPC, sorry, and E&C margin, it has been impacted by, as you say, COVID-related costs. But it's also been impacted by project mix, and some contract losses on a small number of projects, with a partial offset from overheads and tax. I will provide a full breakdown at the full year. What we said previously is COVID-related costs have knocked about just over 1% of the margin at the half year. But I would highlight that frankly more material impact on margins this year have been those contract losses. And you remember in particular the substantial proportion of that is the Jazan commercial settlement that we announced in the first half and talked you through the half year numbers. That project is now substantially complete.

And our question is from the line of Mark Wilson from Jefferies.

I'd like to ask about firstly on the pipeline, just to check. The $42 billion you talk about before the end of '21, does that include the $8 billion that has been tendered in the second half of this year? That's the first point.

It does, Mark. So until such time as they are awarded either towards or to another competitor, we do include it in pipeline.

Okay. So talking -- so going back to the $8 billion then, is there any -- is that mainly in the Middle East? And would you expect any of that before, let's say, Q1 '21?

It's actually a pretty diverse mix, and the majority is in Middle East. In fact, the majority is in the UAE, so 3 contracts, which aggregate up to just over 4 billion, so a little over -- between 50% and 55% of those tenders. Though the rest are spread out pretty geographically in parts, demonstrating how we are trying to diversify our backlog. So we have a large project in Uganda, which we're pursuing. But we also got bids in the likes of Kazakhstan, Oman, Thailand and in offshore wind in Europe. So a pretty broad range in that $8 billion that we've tendered. It's a little difficult to be precise when these awards will be made. In one case for example, it's been retendered several times. We're hopeful that -- we expect it to be awarded in the first half of next year. But how much of it is in the first quarter, it's difficult to tell.

Okay. And I did notice that E&C backlog for '21, looks slightly down on what it was at mid-year. So there's been some deferrals. Is that mainly COVID activity related?

In '21, sorry?

Yes. You showed a $2.2 billion in Q3 for '21 versus $2.3 million at mid-year, so it's slightly.

Yes. I think it's it will be related to COVID. I mean we have no contract losses, so it is simply the phasing of the projects as we now expect them. The one thing that has changed I think from the half year, we were hoping to see some pickup in activity and less disruption from COVID the tail end of this year and early next year. It's clear as has been self-evident from everything that's happened in Europe and the second wave that we are seeing substantial COVID disruption again. So that is having an impact on our projects, and we're being a little bit more prudent as to the forecasting the scheduling of projects in '21 and '22.

Our next question is from the line of Kevin Roger from Kepler Cheuvreux.

I hope that everything's going well. Just on the net debt, so you had the month of November with a debt to $270 million (sic) [$272 million]. I was just wondering if you are expecting, let's say, a big catalyst or something like that in December to improve this net debt position with for example, a payment on contract? Or we should expect basically the net debt in November to be equal to the net debt in December, please?

Kevin, let me say that is a number as at the end of November. Last few periods, we've been reporting the most recent month-end number rather than giving you a forecast. The year-end outcome will reflect net working capital movements in December. That's always a little bit difficult to predict how that will go. Traditionally, we've marginally outperformed, i.e., we've benefited from working capital inflows. I'll stop short of predicting that in this instance. But suffice to say, we are focused on conserving cash and protecting the balance sheet, and we continue to target returning to net cash in the near term. So look, we'll do everything we can to manage working capital well. We've been actually doing that pretty well this year. We have experienced a working capital outflow in 2020, which we flagged in February. The other reason for net debt being higher than we had originally anticipated earlier in the year was the $100 million shortfall in disposal proceeds from the Mexico sale, which we continue to pursue. But yes, we're doing everything we can to improve working capital and we'll have to wait to see how the year-end turns out.

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

On the tendering pipeline, the projects which have been around for a while aside things like Hail and Ghasha, Dalma obviously, which I think is being retendered, are you seeing clients trying to bring down pricing in any significant way? And if so, how much of pricing or things like working capital terms changing, versus when you first started tendering these projects?

Sure. I mean Dalma is the one contract that has been retendered, and that's pretty well known. The other contracts just frankly are taking longer to be awarded. Inevitably in this environment, clients are very focused on pricing and costs. They're seeking to value engineer these projects as much as possible to reduce costs. They're looking to us to try and help them with that. And they're taking the advantage of time to try and obviously secure the best possible price for them. So I think look, pricing is competitive, but we haven't resorted back to this environment we were in 2012, where we saw some peers bidding out losses for contracts. The issue is just the award of contracts by clients who essentially managed their cash flows. Now there are some positive signs there. So for example, you would have seen that ADNOC reiterated its commitment to its 5-year plan, its commitment to increase its production of 5 million barrels a day. It meant that all the projects actually that was in its 5-year plan when they last published it. But there was a modest, I emphasize modest decrease in the size of that capital program. I think about $132 million to about $120 million, 20-odd million -- billion dollars. And that simply reflects their view of their ability to secure better pricing. In terms of working capital, we haven't seen a material change in working capital terms and contracts. We are generally still able to secure positive working capital dynamics. Of course in any project, and this was no different 3 or 4 years ago, there are periods during a contract life cycle where you may -- you may be experiencing some net working capital. But generally speaking, we are able to manage that position. And to the extent we can't, we just price the cost of the credit into the contract price.

And as a quick follow-up to the working capital question you had before, are you seeing payment terms for the contract you're currently executing extend? Or are clients are still paying in the same timely manner that they were before?

So if I can differentiate between sort of client payment activity once the invoice is issued, I have the credit cycle extended once we've issued the invoice to manage DSO tied up in pre-invoicing working capital. We haven't seen any material change in clients' payment behavior, so they're still paying on time. That means that once we issue the invoice, we are seeing clients pay. And we have no bad debts, and it's followed the traditional pattern. The biggest challenge, I think, is though, and you saw this at the interims, we saw DSO pick up in part because -- to a large part, because clients are managing their working capital, but they are squeezing supply chain. And arguably, the simplest way they can do that is to not approve the invoice in the first place, to drag their feet. And in some cases, because they had a lot of their staff out of the office because of COVID restrictions. So the biggest challenge actually is securing the approval for invoices, so we can invoice therefore -- and therefore collect the cash. And it's -- there's no doubt that clients are seeking to try and manage their working capital. But we do have back-to-back arrangements in place. We are managing working capital well. And as I said, the working capital outflow we've seen this year was entirely as expected.

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

Great. Thank you for the update today. I just wanted a quick question on sort of the bidding pipeline and the sort of the mix going forward. So with the sort of decreased focus on the energy transition, I think previously, you had commented that the aim was for renewables to be around 10% of the business in the next 2 to 3 years. It looks like in terms of the bidding pipeline, that's still about right. But in terms of order intake year-to-date, we're kind of running materially higher than that. Is that sort of 10% mix sort of broadly the right thing to think about in terms of ambition? Or is that kind of something that's evolving within the company at the moment?

Thank you, Amy. So yes, you're right. I mean it's an interesting observation that 25% of our awards this year have been essentially in energy transition projects in the CCUS, offshore wind, hydrogen, all very promising and building on the track record we're increasingly developing. About 11% of the pipeline today of about $42 billion is in new energies or renewable projects. So about 4 -- just over $4 billion in E&C and almost $0.5 billion in EPS is all focused on offshore wind, power transmission, solar and hydrogen. And look, our ambitions are much greater, but it will take time. At the moment, the business is generating about $215 million of revenue a year. We'd like to develop that to be a much more substantial part of the business. Sami is looking at that at the moment. It's one of the things I'm sure we'll share more details on with you during the course of early next year. But for the time being, we have got a good platform. We've got projects, let's say, across the spectrum including hydrogen, carbon capture and power and offshore wind. And we want to develop those.

And our next question is from the line of Amy Wong from UBS.

A couple of questions from me and focused on 2021. Thinking about additional cost savings that you are implementing now, you do say in the release that the focus is to be about protecting margins with -- and pricing continues to be under pressure. So just kind of bridge where we are this year. You obviously have more cost savings in 2021. But then there -- it sounds like we're going to start with a lower revenue -- hence -- by extension, activity. How should we think about the margin dynamics into 2021?

Amy, I fear I'm going to disappoint you with my answer on this one.

I tried.

It's a little premature for me to be drawn on 2021 guidance. We are planning to do that at the full year numbers early next year. I think -- let me see how helpful I can be. On cost savings first, so increasing those by 25%, this is absolutely in the square -- in our strategic priorities for the year, but -- well for next year. They have been this year, too. So cutting costs, one of our 4 priorities. We've -- we're on track to deliver $125 million this year. That has significantly helped protect margins this year. We've also -- we are increasing that to $250 million next year. And I'll just -- it comes with the usual caveat, these are gross cost savings. As you'll appreciate, that is pretax. And secondly, the substantial proportion of that relates to project support costs. Under IFRS 15, the benefit of those savings is spread over the life of the contract themselves. So it doesn't all flow to the bottom line in 2021. But it is predominantly, as you might imagine, head count and a proportion of nonstaff costs as well. So that is what we're doing to try and protect margins. You saw the first half margin in E&C. We will see -- there are some -- a small number of contracts are ongoing. In fact, we've reported some contract losses that will weigh on margins next year in E&C. And EPS margins have structurally been normalizing over the last few years as the historic high-margin contracts in Iraq have rolled off. So we'll see a continuation of that trend as well. But look, Amy, for you, forgive me. I won't answer the question specifically on giving you guidance for '21 now. You'll have to bear with me until early next year.

Fair enough, okay. And then I want to just pick up on your point on the small contract losses that you're flagging here as well. Because yes, I think you guys called out design in the first half. Now these small contract losses that it sounds like are materializing in the second half this year, can you give us the nature of why they are -- have these projects completed? What's the nature into how they're arriving?