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Tecnicas Reunidas: Well positioned for a solid recovery

Publication Date: 17 May 2018 - By Enrico Damioli By Enrico Damioli
Actionable
Differentiated

Equity Fundamental Equity EU ex-UK MENA Energy

Quite like most stocks in the oil and gas sector, Spain-based general contractor Tecnicas Reunidas has been under pressure lately, but its strong and growing backlog and its focus on the downstream suggest a strong resilience to the oil price, which has of late shown signs of strengthening itself.

Furthermore, recurring clients (ca. 49% of revenues) for complex and strategic projects mean a strong quality in the execution and a net cash position gives the company competitive advantage to sustain the stress of the market. 

An average ROIC of 36% and a revenues growth of 20% in the next 5 years combine to create a compelling investment that has been undervalued by the market. 

In the mid 2014 the oil price collapse put the oil and gas industry under big pressure. Suddenly what was an almost under-suppplied commodity, became an over-supplied commodity. The US oil independency on Arabian countries and the weak role of the OPEC in moving the oil prices raised one of the biggest fear in the financial markets: uncertainty. 

As the storm mounted, the oilfield services industry was heavily hit, as what really matters for the such companies are the investments coming from the oil companies (that translate into orders), and those started to lack. 

Inevitably, given the nature of Tecnicas Reunidas’ business, akin to almost all the companies connected to crude oil, the stock has been under pressure in the capital markets lately.

If we try to struggle against the cognitive bias that leads to consider everything linked to crude oil as a whole, we can see that Tecnicas Reunidas is mostly active on the downstream (normally quite resilient to the oil price) and experienced growing backlog and revenues since 2012. 

In particular, backlog grew +62% (CAGR 10%) in the last 6 years compared with an average of +26% (CAGR 3%) of a close panel of competitors, whilst the revenues grew +78% (CAGR 12%) in the last 6 years compared with the panel average of +45% (CAGR 6%). 

Despite these good indicators the stock price lost almost 42% in the last five years. 

One of the main concerns of the market is the reduction in the operating margins (EBIT) that decreased from an average of 5% over the last 10 years to 2% in 2017. 

Updates following Q1 2018 conference call 

On 14 May 2018, Tecnicas Reunidas published its first quarter of 2018, showing a 0,4% of EBIT margin and a revenues fall of 16% compared with Q1 of the previous year. The market reacted very badly to this news, making the stock decrease by more than 5% in two days. 

Nevertheless, the management had been very clear on this since the November 2017 profit warning when, saying non-recurrent factors would impact revenues and operating profits. The stock price decreased by 31% in one day, and that’s when in my opinion the stock began to be worthy of a closer look. Non-recurring factors were: 

- Delays and cancellations of some big projects 
- Difficulties in the recovery of extra costs incurred on some projects at later stages 

The situation it’s well represented in the graph below: 

Over the last two years (2016 and 2017) only €2.5bn of projects were launched. Furthermore, €5.3bn worth of projects have started (or are expect to start) in the first few months of 2018, but due to the nature of the jobs in this industry they have not yet affected revenues and profits. 

So, the bad story here is that the situation anticipated in November with the profit warning is dragging into the first half of 2018, but nothing new under the sun. The backlog is safe and I don’t see any further concerns that would complicate what it seems a temporary circumstance. 

The management is maintaining core capabilities despite the lower level of activity and this is pushing higher both the idle costs (lowering the margins) and the confidence on the management for a close recovery. 

The positive takeaway from the company’s last press conference: despite the fact that the backlog picked the exposure to Middle East (74%) the company showed a strong bid pipeline with 56% of the bids outside Middle East, suggesting potential growth in diversified markets. 

Valuation: DCF model has been used, with WACC 9% and growth rate 2%. 

Worst case: Target price set to €31.0
 
Based on the following assumptions: 
- For 2018 revenues and margins in the low end of management guidance (€4.3bn and 1.5% respectively). 
- 3% to 5% annual revenues growth over the period 2019-2022, then 3% towards 2032 
- 3.5% of operating margins over the period 2019-2022 (well under normalized margin of 5%) 

Best case: Target price set to €35.9 

Based on the following assumptions: 
- For 2018 revenues and margins in the high end of management guidance (€4.6bn and 2.5% respectively). 
- 3% to 5% annual revenues growth over the period 2019-2022, then 3% towards 2032 
- 4.3% of operating margins over the period 2019-2022 (still under normalised margin of 5%) 

Disclosure:

I have no positions in any of the securities referenced in the contribution

I do not use any non-public, material information in this contribution

To the best of my knowledge, the views expressed in this contribution comply with UK law

I agree with the terms and conditions of ReachX

This contribution is for informational purpose and does not constitute investment advice nor is it an offer to sell or buy, nor is it a recommendation for any security.

Enrico Damioli

 

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