Get onboard RPS in 'slack water'

The severity of the resultant pullback in industry capital budgets weighed heavily on earnings and cash flows for corporate entities with significant exposure to oil and gas markets, but we believe that we've arrived at 'slack water' - a flat period for expenditure prior to the next expansionary phase. Indeed, data from Baker Hughes suggests that while the North American rig count is down by a fifth since this time last year, the number of total active rigs has been steadily rising since July. Any revival in industry capital expenditure should result in a substantial earnings recovery for companies such as RPS (RPS), an Oxfordshire-based multinational energy resources and environmental consultancy.

The market difficulties experienced by RPS are reflected in a 55 per cent peak-to-trough fall in market value since the beginning of 2014, as it gave way to a profit warning in the first half of 2016 and at the same time calling time on a 20-year record of annual 15 per cent dividend increases. But the shares started to retrace during the final quarter of last year and analysts have tentatively started to nudge earnings forecasts upwards. We think that's likely to continue through 2017 as self-help measures are brought to bear and further signs of a recovery in end markets emerge.

The effects of depressed energy prices have not only put pressure on fees and margins in RPS's energy business. Its Built & Natural Environment (BNE) business's customers in both Europe and North America have some exposure, and the same is true for the Australia and Asia Pacific division, which also has clients in the mining sector that have felt similar pressures. But as the chart below shows, it is profits from the energy division that have been the biggest source of pain.

Profit breakdown

RPS reacted to the downturn in the energy business by cutting headcount and closing offices, and booked a sizeable £2.4m reorganisation charge at the half-year mark. This means, after dropping into the red in the first half of 2016, the division is expected to break even for the full year. But with the oil price looking more stable, we think the surprises could be on the upside in 2017, especially given the dramatic effect increased staff utilisation levels and fees can have on profits.

Another positive factor for 2017 is that the election of Donald Trump could provide a significant boost to US infrastructure spending, which is certainly favourable to the BNE-North American segment. Improvement in US construction activity was already evident before the election, and in October 2016 seasonally adjusted construction spending was up 2.6 per cent year on year, according to the Associated Builders and Contractors' analysis of US Census Bureau data. That said, Mr Trump's views on environmental policies may be less positive for the group's environmental businesses.

In the UK, meanwhile, the impact of the Brexit vote has not been as bad for RPS as originally feared. And sterling's depreciation should boost reported overseas earnings in the second half.

There is some uncertainty over the dividend after management called time on the two-decade record of 15 per cent annual increases. However, expectations that the payout will be maintained, while not key to our enthusiasm for the shares, do not look far-fetched. Cash generation has remained strong and the group has said it plans to rein in investment and acquisitions. Meanwhile the debt-to-profit ratio of 2.2 is well beneath the bank covenant of three times and is expected to contract during the second half through to December.