Oil and gas services provider Petrofac (LSE: PFC) has lost 50% of its value over the last three months after admitting that its the subject of a Serious Fraud Office investigation.
For anyone who wants predictable and consistent returns from their investments, it probably makes sense to stay away. But having looked at the groups accounts, I believe the shares may now be significantly undervalued. Ive invested a significant amount of my own cash in Petrofac, which is now my largest personal shareholding.
How cheap is the stock?
My calculations show that at 450p, the stock is trading on a multiple of 6.9 times 10-year average earnings. This measure, known as the PE10, is often used to gauge a stocks value relative to its long-term performance. Looking ahead, current broker forecasts are consistent with this. The stock trades on a 2017 forecast P/E of 5.8.
Petrofac also looks cheap relative to the amount of cash its generating. The firm generated free cash flow of $386m in 2016. Thats equivalent to a price/free cash flow ratio of 5.2, which is exceptionally cheap if its sustainable.
Lastly, broker forecasts for a dividend of $0.59 per share give the stock a prospective yield of 10%. This payout may be cut, but even if halved would still be attractive at 5%.
What could go wrong?
The risks for investors are that the SFO investigation will harm Petrofacs ability to win new work, and that it may result in a large fine.
The company also faces tough trading conditions due to the slow recovery of the oil market. Itslatest trading statement met with a fairly cool reception and analysts have trimmed 2017 earnings forecasts by 11% to $1.02 per share since April.
Weighing the risks here isnt easy, but my view is that most of the bad news is already in the price. I believe the shares could perform well over the next few years.
A success story
One of my other top five shareholdings is FTSE 100 mining group Rio Tinto (LSE: RIO). Ive held this stock for several years, but I purchased more last year when the price dropped below 2,000p.
Its proved to be a good buy. The shares are now trading at 3,375p and Im still holding. In reality, I think most of the big gains from last years mining market recovery are already in the price at Rio. But the firms profitability and renewed focus on cost control and shareholder returns means that I still see it as an attractive share to hold.
Consensus forecasts suggest that the dividend will be increased to $2.54 per share this year, giving a prospective yield of 5.8%. The stock trades on a forecast P/E of 9.8, which also seems attractive.
However, analysts expect the groups earnings per share to fall by about 24% in 2018, presumably due to changing market conditions. The dividend is expected to fall by a similar amount, putting the stock on a 2018 P/E of 13 with a 4.7% yield.
This doesnt seem obviously cheap, but its worth noting that mining forecasts can change fast. Consensus profit forecasts for 2018 have risen by 10% over the last three months. Im going to sit tight for a little longer yet.
Fast track to early retirement?
If you’re hoping to build a stock portfolio that will help fund an early retirement, then I believe you’ll need to consider a mix of stocks. Focusing too heavily on risky plays such as Petrofac carries the risk of big losses.
To help you get started, we’ve produced The Foolish Guide To Financial Independence. This exclusive new report contains details of possible stock picks and an investment plan to help maximise your savings.
This essential guide is free and without obligation. To download your copy today, click here now.
