Broker tips: Pearson, Balfour Beatty, Petrofac

29th Sep 2014 16:27

Publishing group Pearson has its long-term attractions but faces immediate trading and execution risks, with the resulting trade-off more than reflected in its current valuation, Westhouse Securities believes.Hence, the current share price offers a profit-taking opportunity when compared to these analysts' price target of 1,001p for the stock.Indeed, the company is an "interesting" play on long-term structural change in the global education market, thanks to its trusted brands, a broad customer base and robust finances, Westhouse deems.Pearson should also benefit from population growth, increased public/private sector spending and the expansion of the middle class in emerging markets – including strong demand for English and the transition towards digital product and platforms.Nevertheless, the cultural change being undertaken by the firm "carries further execution risk". Furthermore, print products still account for approximately 40% of revenues. Hence, a significant digital migration remains to be negotiated.That transition, together with the disruption of several of the firm's core markets, will hold back growth over the broker's three-year forecast horizon. US dollar exposure could also constitute a potentially disruptive factor.For all of the above reasons Westhouse Securities has initiated coverage of Pearson at 'sell' with a price target of 1,001p. Balfour Beatty is impossible to value at present.The problem contracts at the comparatively "tiny" Engineering services unit within the company's UK construction arm are a "potential black hole" which threatens the financial health of the group, analyst Alastair Stewart at Westhouse Securities wrote to clients in a note on Monday.That is the reason that average net debt has increased at an alarming pace, as contagion begins to extend to other parts of UK construction. So much so in fact that another profit warning may follow, Stewart claimed.In the company's latest trading update the firm's executives claimed that factors such as "slippage" and "poor delivery" were behind a reported £75m shortfall, £30m of which originated in the problem London contracts.The resulting KPMG review of the firm's UK contract portfolio, the possibility that management failed to keep pace with the deteriorating outlook and the prospect of a new chief executive arriving, "could potentially result in a further significant write-down"."Today's £240m Sellafield nuclear contract win displays Balfour at its best, but we are concerned that the problems surrounding the smaller contracts are undermining the group's many strengths," the broker added.As of 15:55 shares of the constrcution outfit were off by 16.76% to 1,872p.Shares of oilfield services firm Petrofac have been de-rated too far while the outlook is still robust, even when accommodation is made for some of the company's weaknesses.The stock is now at a four-year low, near 1,000p, and trading on 8.2 times' the estimated 2015 price-to-earnings multiple. That represents a 20% discount to the wider European sector. Other fundamental ratios tell much the same story, Credit Suisse writes. The company, for example, is on just 5.1 times' next year's EV/EBITDA multiple – for a 30% discount to its historic average.The latest directors' dealings are also supportive of the investment case, as is the company chief's 18% holding. Together with a solid balance sheet that means that the firm's dividend pay-out is "underpinned".The key risk to Credit Suisse's positive rating is the trading update due out on 16 December. Petrofac then needs to deliver on 77% of its earnings guidance for fiscal year 2014, "which appears challenging". Yet backlog for execution covers 75% of the revenues forecast for next year, the broker adds.As a result of all the above Credit Suisse has moved to an 'outperform' recommendation on Petrofac, from 'neutral' beforehand, but stuck with its price target of 1,340p.The latter factors in a discount of approximately 10% to account for a "structural de-rating for corporate management concerns and falling returns on rising investments".