UK Edition
Seeking to “catch a falling knife” is, by definition, a highly precarious activity. It involves buying a company’s shares following a large fall in their price. The aim is to buy them at their very lowest ebb in order to benefit from a subsequent recovery.
However, as the phrase suggests, purchasing stocks when they are in freefall can result in severe pain and substantial losses. Investors who have bought shares in Wood Group over recent years, for example, are likely to be deeply in the red.
Shares in the firm, a consulting and engineering specialist that focuses on the energy sector, have fallen by 43pc over the past year. Over the past five years they have shed 76pc of their value while the FTSE 250 index of which the company is a member has gained 27pc.
The company’s disappointing financial performance is a key reason for its dwindling share price.
Covid has caused significant disruption for the business. The pandemic contributed to a 24pc decline in revenue in the 2020 financial year as major projects were delayed in response to an uncertain economic environment.
This trend persisted in 2021 and caused Wood Group’s first-half revenue to fall by 23pc compared with the same period of the previous year. More recently, its latest trading update included a downward revision to revenue and profit expectations compared with those provided at the halfway stage of its 2021 financial year.
Previously, at the time of its half-year results, it had forecast full-year sales of between £4.9bn and £5bn as well as an “Ebitda” (earnings before interest, tax, depreciation and amortisation) margin of 8.8pc.
However, thanks to the ongoing deferral of activity and contract awards in its end markets, the company now expects revenues of £4.7bn and an Ebitda margin of 8.6pc for the full year.
In addition, it now expects net debt to be higher than previously forecast. The company forecasts that it will end the year at the same level that was reported in its half-year results. A further update on its performance is due on Thursday.
In Questor’s view, further uncertainty could be ahead for the energy industry. Rises in inflation, which recently reached a 30-year high in America and a 10-year high in Britain, are likely to nudge central banks towards a less accommodative monetary policy.
This could act as a drag on the global economy’s growth rate, which could lead to further delays across the major projects on which Wood Group consults. Higher official interest rates may also inhibit the pace of transition towards low-carbon assets across the energy sector as businesses’ borrowing costs rise in harmony.
Even if the company delivers on consensus profit forecasts in the 2022 financial year, its price-to-earnings ratio of 20 for that year suggests that its shares lack a margin of safety.
And, after the company’s recent announcement of a strategic review of part of its consulting business, which accounts for around 15pc of its revenues, market sentiment could remain weak as investors await an improvement, and greater certainty, in its financial prospects.
Of course, the global agreement to speed up action on climate change that resulted from Cop26 provides significant opportunities for companies such as Wood Group. The world’s shift to renewable energy will require vast investment over a sustained period, which could create better trading conditions for the company in the coming years.
Moreover, its switch towards higher-margin consulting work, cost reduction plans and last year’s resolution with authorities in relation to historical bribery and corruption allegations pave the way for an improvement in financial performance.
Meanwhile, an 18pc increase in the size of its order book in 2021 suggests its overall strategy is not without merit.
However, continuing poor financial performance, an uncertain economic outlook and a share price valuation that is not yet sufficiently attractive to merit purchase mean there are better investment opportunities available elsewhere. In Questor’s view, trying to catch this particular falling knife is simply not worth the risk.
Questor says: avoid
Ticker: WG.
Share price at close: 206.5p
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