As we head towards the end of the first trading month of 2016 there has been no let-up from the volatility of last year. Indeed, the trend has been decidedly downward since the turn of the year as investors fret about China, oil, political instability and many other macro factors on their radar.
A canary in the coal mine?
Some may remember the origin of the canary in a coal mine. The metaphor originates from the times when miners used to carry caged canaries while at work. If there was any methane or carbon monoxide in the mine, the canary would die before the levels of the gas reached those hazardous to humans.
Now before I type any further, I should warn readers that it can be a dangerous, not to mention expensive, game to forecast the prospects of other companies based on the reports of others. However, in this case, I think it’s worth exploring further.
While sat at my trading desk on Monday, I read a trading update from Plexus Holdings (LSE: POS) a smaller player in the Oil & Gas Related Equipment and Services sector. Now, while this company may be small, it does have some market-leading technology in the Python Sub-sea wellhead and its POS-GRIP products. These are supported by much larger companies such as BG Group, Total and Maersk. It also has a licensing agreement with major Chinese oil and gas manufacturing company Yantai Jereh Oilfield Services Group Co. to help distribute and market its POS-GRIP products to the wider global market.
Management reported that since the year-end, and in light of the weakness in the oil price, there was an increasing number of projects that were either delayed, postponed or cancelled. Accordingly, management expected earnings to be very significantly below market expectations. As you may expect, the shares fell out of bed, and despite a small recovery yesterday they’re less than half the price that they closed at on Friday.
A sign of things to come?
As we can see from the chart below, the only share under review here to outperform the FTSE 100 is Petrofac (LSE: PFC), however over a three-year period it’s on par with Amec Foster Wheeler (LSE: AMFW), both underperforming by over 50%.
It probably won’t come as any surprise to find that both companies are among some of the cheapest (on a 12-month forecast P/E basis) on the market. Both trade on multiples between seven and eight times forecast earnings, compared to the FTSE 100 forecast of around 15 times expected earnings according to data from Stockopedia.
That says to me that the market is worried that (like we have seen at Plexus) expected earnings could be subject to downgrades going forward, which in this market would surely send the shares in the wrong direction.
However, the opposite would be true should these companies manage to maintain expectations. Let’s not forget that these are businesses with size and scale, and with a steady hand they should be able to navigate the downturn.
Add into the mix the 5%-plus dividend yield on offer from both companies and it’s simple to see the attraction, despite the pessimism in the sector currently.