Why Petrofac Limited could be too cheap to ignore

Updated: 
Petrofac oil pipes

Shares of oil services group Petrofac (LSE: PFC) fell by 15% to 700p on Friday, after the firm said that it was under investigation by the Serious Fraud Office (SFO).

The SFO investigation is believed to relate to Petrofac's past dealings with a company called Unaoil. Monaco-based Unaoil has been the subject of allegations that it used bribery to secure contracts for western companies, including Petrofac.

Prior to Friday's sell-off, I had been eyeing Petrofac as a potential oil recovery buy. The group's shares were trading on about 9.3 times forecast earnings, with a prospective yield of 6.3%.

The question I need to answer now is whether the risks and potential costs of the SFO investigation should rule out Petrofac as a possible buy.

What do we know?

Petrofac has previously said that it used Unaoil for "local consultancy services primarily in Kazakhstan between 2002 and 2009". Back in August 2016, it said that it had hired lawyers and forensic accountants to conduct an independent investigation into the Unaoil allegations.

According to Petrofac, this investigation "did not find evidence confirming the payment of bribes". The company said that it had passed its findings to the SFO.

Friday's sell-off may have been influenced by events at Rolls-Royce, which recently agreed a £671m settlement with the SFO relating to bribery and corruption allegations.

A fine on this scale could be painful for Petrofac. But Rolls-Royce shares have continued to recover strongly and the payment schedule seems unlikely to impact the firm's underlying recovery.

I'm tempted to suggest that Petrofac will be able to ride out this storm, whatever the eventual outcome of the investigation. The group's profits are expected to recover this year and net debt has halved since 2015.

Petrofac currently trades on a P/E of just 7.9, with a covered dividend yield of 7.2%. Although this stock isn't without risk, I think the shares could be a profitable buy at current levels.

A real oil bargain?

Premier Oil (LSE: PMO) were up 4% on Monday morning, after the firm said oil and gas production had risen by 44% to 82,600 barrels of oil equivalent per day (boepd) during the four months to 30 April.

Although full-year production guidance has been left unchanged at 75,000 boepd, Premier's costs have also been lower than expected. The company said operating costs for the year to date were $13.70/boe, 11% below budget.

A P/E of 2

In today's update, Premier Oil said that its refinancing plan is now underway. The group's net debt remains unchanged from December at $2.8bn and management expects a "more significant debt reduction in 2018".

As things stand, Premier's market value is just £301m. But the group's enterprise value (market value plus net debt) is £2.4bn. If debt falls to plan, then the value of the group's shares should rise to reflect this.

The risk, of course, is that oil prices will remain stagnant and Premier's net debt will take longer than expected to reduce. The group's stock currently trades on a 2018 forecast P/E of two, suggesting the market still sees a lot of risk here.

I share this view. I think investors considering Premier as a turnaround buy need to be able accept a high degree of risk and potential losses.

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Roland Head has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Petrofac. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.