The City loves a good recovery story, but sometimes it gets carried away. Take this international project management and services company, once seen as a rising star. After a series of profits warnings, due to underperforming contracts and expensive compensation claims, the company's reputation and its share price were in tatters.
Turkey of the week: Amec (AMEC), tipped as a BUY by UBS
Since then a new chief executive, Samir Brikho, has been recruited; and after a root-and-branch review, he concluded that the business is in a mess. The review highlighted the reasons for Amec's failure: a complex organisational structure, high overheads, a lack of focus and ongoing litigation.
As a result, Amec plans to become leaner cutting £100m of annual costs and to focus on its more attractive markets of offshore oil and gas, mining, and environmental and nuclear and wind power infrastructure. These core units generated 2005 revenues and operating profits of £1.8bn and £83m respectively. The objective of the cost-saving programme is to improve the underlying profit margin from its current 4.6% to 6.0% by 2008. At first glance, this seems achievable when compared to peer group averages of around 5.6%. But these industries are presently enjoying strong demand, due to booming energy and commodity prices these margins may not therefore be sustainable.
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The next step is to sell the construction and infrastructure units that accounted for £1.3bn of turnover in 2005 but only £14m of profits. The first disposal came last week, when Amec sold its 50% stake in its joint-venture rail-engineering business to Bouygues Construction for an undisclosed sum. The CEO has impressed the City, driving the share price higher, which has so far protected Amec from private-equity groups. Amec was the target of a takeover bid at 450p in November from Texas Pacific and First Reserve, but the bid was rejected as being too low.
But was it really too low? I would value Amec's core operations on a 2008 p/e multiple of 14 (assuming margins of 5.6% are delivered) around 395p per share. Discounting this back into today's money at 10%, and adding a further 80p for the disposals (or £250m), gives a total value of around 410p per share. And Amec may in fact struggle to hit the targeted 5.6% margin. So, with the stock currently trading at 461.75p, I would recommend taking profits. Yes, bid speculation will provide support in the short term, but if this fades away, then I see the stock falling back towards the 400p level. And as the private-equity guys have already balked at these lofty levels despite their abundant supply of cheap money I believe the overall balance of risk for shareholders is on the downside.
Recommendation: TAKE PROFITS at 461.75p
