Oversold Amec Foster Wheeler ready to recover

The group applies its engineering expertise to infrastructure assets across a range of industry sectors, including oil and gas, mining and power generation. The AMFW tie-up, which was initiated after Amec's unsuccessful tilt at industry rival Kentz Corp, expanded the group's oil products and petrochemicals business, while providing it with greater exposure to less-cyclical revenue streams from national oil companies (NOCs) in Saudi Arabia and the UAE. The combined group would have generated in excess of £500m in pro-forma trading profits for 2013. The combined order book of £6.3bn is comprised primarily of reimbursable 'costs plus fixed margin' contracts. These commercial arrangements, along with the aforementioned NOC revenue streams, are generally regarded as reasonably predictable. The business is therefore relatively low-risk in terms of both margins and project cancellations. It's also worth mentioning that, even prior to the merger, Amec had an extremely high rate of converting contracts into cash flows.

But AMFW obviously hasn't been immune to the fall-away in crude oil prices. The group's share price has fallen 30 per cent since the end of June. This partly reflects a reduction in the number of potential remits from the oil and gas industry, but AMFW has fared better than less-diversified sector rivals. AMFW now generates around 45 per cent of revenues from other industries, which provides a degree of insulation against continuing oil price weakness. The Foster Wheeler deal also provided diversified exposure to downstream oil and gas segments, such as refining and petrochemicals, in addition to capabilities linked to gas processing.

Leaving hydrocarbons aside, the group's valuation was subject to another reassessment in January, when the UK government stripped the specialist private consortium, Nuclear Management Partners (comprising of Amec, US engineering group URS and the French energy firm Areva), of a £9bn contract to clean up the nuclear waste site at Sellafield. The decision by the Department of Energy and Climate Change was curious given that it came barely a month after the newly merged engineering group was handed the environmental services deal for the proposed new nuclear power station at Moorside, Cumbria. It's thought that while the Sellafield decision will only have a limited detrimental impact on group profitability, it could conceivably make it more difficult for AMFW to secure nuclear deals in the future - time will tell.

AMFW has traded at a near-one-fifth earnings multiple discount to industry peers over the past two years. But that discount has now stretched to 48 per cent, implying near-60 per cent upside from the current share price. The group's shares also now change hands at a 17 per cent discount to the 200-day moving average. Admittedly, the implied share-price upside is lower based on City analysts' target prices, with Goldman Sachs recently reaffirming its 'buy' rating with a 945p target, while Nomura's 'buy' call envisages 1,000p.