Reflecting on WorleyParsons

Competitive, cyclical and largely homogenous, engineers sit snugly alongside steelmakers and airlines as lousy businesses. With low barriers to entry, competition is fierce. Grand investment plans are made when optimism reigns but when the mood changes, dollars vanish into thin air. Cyclical barely describes the reality. Such businesses are typically awful investments.

But like flowers grown in dung, lousy industries occasionally produce companies of rare quality. Posco, a steelmaker that actually turns a reasonable profit and Southwest, a US airline, are but two foreign examples. Engineering outfit WorleyParsons makes a strong case for being a third.

Since listing in 2002, revenue has climbed, on average, 55% a year. Dividends have grown from 5 cents per share in 2003 to 86 cents per share last year. Earnings per share, of 17 cents per share upon listing in 2002, now stand at $1.48 per share (see Chart 1). Founder John Grill has been crowned the eighth richest man in the country and the company has made as many millionaires as a flash investment bank.

The difficulty is in determining whether this success is due to genuine business quality or whether the resource sector boom has made an ordinary business look very good. That’s the question we’ll address in this review, our first on the company.

Growth or cyclical?

There’s a case to be made for both arguments. There is no doubt Worley has benefited from a remarkable boom. Oil prices have risen from lows of US$10 in 1999 to over $140 in 2008; they still sit at over $100 a barrel today, encouraging higher output and driving investment in the sector; more than US$500bn was spent searching for oil and gas last year.

Expenditure on fresh exploration, new projects and capacity expansions—exactly the kind of work that requires advanced engineering skill—are driven by the price of oil. It is no accident that Worley’s revenues have exploded at a time when energy prices have done the same.

Although oil and gas (hydrocarbons) remains its largest source of revenue (see Chart 2), new businesses have also blossomed. Power, infrastructure, environmental consultancies and of course mining have all boomed simultaneously.

And Worley hasn’t been shy about chasing new business; it’s made dozens of acquisitions and aggressively grown staff levels and overseas offices. Last year alone over 1,000 new staff were added to take the company’s headcount to over 35,000. Worley today operates from over 140 offices in more than 40 countries.

Yet Worley has done more than simply ride the boom. The comparison with local peers in Table 1 shows higher earnings before interest and tax (EBIT) margins and better returns on capital. How has Worley managed to command such impressive metrics? Two qualities standout; discipline in chasing work and flexibility in tendering.

Like a siren song, chasing projects, especially prestigious ones, is alluring but often ends badly. Worley, for example, has suffered severe reputational damage in pursuing Woodside’s aggressive timetable at Pluto. Mostly, however, a hallmark of Worley is conservatism in project selection.

Similar to insurance companies, engineers receive upfront payments when business is won. There is therefore a temptation to bid too low with an eye on immediate cash and definite work, an approach that almost always results in disaster. Just as the best insurance companies are marked by the policies they don’t write, an engineer’s success depends on disciplined job selection. Worley has an excellent track record in this area (with Pluto a glaring exception).

Contract pricing

Another key skill is pricing contracts. Worley has shown great flexibility in designing contracts that appeal to customers. Unlike the giants of the industry (Bechtel, for example) Worley can offer a wide array of pricing and work options. This helps win contracts; three years ago Worley had done barely any work for Vale. Today, it is in charge of one of the company’s largest iron ore expansions, work that contract design helped to win.

These are fine qualities but they aren’t fortified competitive advantages. Compared to the best in the industry, Worley displays little in the way of unique, defensible qualities. It spends almost nothing on research and development, has established almost no intellectual property and garners few accolades for its technical nous.

This is a problem. Persistently higher energy prices are driving vital changes in the way drillers search and source oil. As oil prices climb and desperation grows to replace consumed reserves, wells are drilled deeper, complex subsea structures punctured and unconventional reservoirs sought.

Technology is playing a growing role in oil extraction, helping the industry’s giants extend their lead. Halliburton, renowned for deep sea drilling, added 15,000 staff last year to keep up with demand. Schlumberger is winning work with world-leading dual coil seismic technology (see Shoptalk) and Bechtel was awarded US$20bn of new LNG work last year alone. Worley has none of these advantages.

No lasting advantage

It is however a well-managed business generating higher than average returns. But with the absence of any real competitive advantage, investors are at the mercy of the resources cycle. A PER of over 18 and a cashflow yield of 4.3% suggest growth is still aggressively priced in. Greater competition, wage inflation or a fall in oil prices—all very real possibilities—might very well see the stock fall savagely. The illusion of growth could easily give way to cyclical reality.  

‘Greatness’, proclaimed Napoleon, ‘is nothing unless it be lasting’. History can be a lenient judge; despite dying defeated and in exile, Napoleon garnered sympathy, a state send-off and a chapter in history. The business world is much less forgiving, as are we. SELL.