SNC Revamp Undermined by Oil Price Dip: Corporate Canada

SNC-Lavalin Group Inc.’s C$2.1 billion ($1.9 billion) acquisition of an oil-services company announced just as crude prices began to sink in June is creating a new headache for Chief Executive Officer Robert Card.

The deal for Kentz Corp. -- which made oil and gas SNC’s biggest line of business, representing about 25 percent of annual revenue -- has hit SNC’s stock as momentum was building for a turnaround at Canada’s biggest engineering firm.

SNC had lost 15 percent of its value since June 30 through yesterday, tracking a 25 percent decrease in oil prices. SNC had been one of the best performing industrial stocks in Canada in the first half of 2014, rising 17 percent. The stock rose 0.2 percent to C$47.64 today in Toronto.

“We like the company, but the timing of Kentz, which is oil and gas focused, might not have been the best,” Jayson Moss, an analyst at Franklin Bissett Investment Management, said in a telephone interview from Calgary.

Crude collapsed into a bear market this month as Saudi Arabia and other producers deepened price discounts for their oil. Global supplies are climbing as the U.S. pumps the most oil in almost three decades and Russia’s output nears a post-Soviet record. The decline has spurred concern among investors that demand for oil and gas services suppliers such as Kentz may dry up, said Frederic Bastien, an analyst at Raymond James Ltd.

“The market is worried that oil and gas will slow down,” Bastien, who rates the shares market perform, said in a telephone interview from Vancouver. “SNC bought a good company with a strong strategic position, but if there’s a slowdown, maybe the estimates for Kentz won’t materialize. That’s weighing on the stock.”

Projects Canceled

The drop in oil prices has led to about 22 projects being canceled this year, mainly in Canada and the Arctic, Miswin Mahesh, a commodities analyst at Barclays Capital Services in London, said by e-mail.

Card, appointed two years ago, is diversifying Montreal-based SNC’s revenue into faster-growing regions such as the Middle East and Africa, by boosting exposure to the world’s largest oil and gas hot spots.

Oil and gas offers higher growth than other industries, and Kentz -- whose clients include Abu Dhabi National Oil Co., Qatar Petroleum and Kuwait Oil Co. -- will contribute to earnings within the first year, Card said when the deal was announced in June. The acquisition expanded SNC’s backlog by C$4.9 billion, more than three-quarters of which come from “lower-risk” and higher-margin services-based contracts, he said.

High Margins

“Our analysis shows that the oil and gas market over the last decade has overall produced the highest margins, the highest profit figures and the best growth in our industry,” Card said in a June 23 interview. He was unavailable to be interviewed for this story, Lilly Nguyen, a spokeswoman for the company, said yesterday.

Kentz, with 15,000 employees operating in 36 countries, “has transformed SNC’s oil and gas business that really didn’t have the wherewithal to get contracts,” said Moss, whose firm owns SNC stock as part of the C$21.9 billion in assets it manages. “It expands their presence globally, with very little overlap.”

Card took over with a mission to clean up SNC’s reputation and improve profitability after a corruption investigation involving his predecessor. He has improved governance standards, tightened risk-management policies to prevent future misconduct and overhauled the executive suite, according to a presentation Card made at the annual meeting in May.

He’s also been cutting deals as he seeks to anchor the company’s businesses around oil and gas, where it does front-end engineering design and construction management to help clients develop and process new deposits.

Unprofitable Contracts

The Kentz acquisition -- SNC’s biggest since at least 1991 -- followed an agreement in May to sell the AltaLink power-transmission unit to Warren Buffett’s Berkshire Hathaway Inc. for C$3.2 billion.

The CEO and his team are still working to complete a string of unprofitable construction contracts, such as Montreal’s McGill University Health Centre. SNC wrote down more than C$500 million in 2013 “due to decisions of the past,” Card said at the annual meeting.

The company is scheduled to report third-quarter results Nov. 6.

Police Investigation

Another cloud over SNC’s stock is potential litigation.

SNC is being investigated by the Royal Canadian Mounted Police to determine whether the company -- before Card’s hiring -- made improper payments to government officials in Bangladesh and Libya in violation of Canada’s Corruption of Foreign Public Officials Act. It’s also facing a class action suit from shareholders over the company’s governance practices.

While the RCMP and the Quebec government have already laid bribery and fraud charges against former SNC employees, the company hasn’t been charged in connection with the probe.

“We fully cooperate with authorities in order to reach a settlement that is comprehensive, final and fair as soon as possible,” Nguyen said in an e-mailed response to questions. She declined to say whether SNC expects to pay financial penalties in connection with the investigations.

Still, financial penalties are a possibility, said investors such as Bissett’s Moss. Card broached the subject at an investor day in Toronto Oct. 9, saying the company is making “steady progress” in talks with various authorities, according to Benoit Poirier, a Desjardins Capital Markets analyst who attended the presentation. SNC didn’t web cast the event.

“Potential fines are one of the biggest risks that Bob Card sees,” said Moss, who said a penalty in the C$200 million range is a possibility.

Oil Rebound

While Brent crude for next month delivery has fallen to about $86.03 a barrel, the price for 2020 contracts was down less than one-fourth of that to $91.53. Prices may rebound well before 2020. Brent, the global benchmark, will climb to as much as $100 a barrel next year, according to Sanford C. Bernstein & Co., Standard Chartered and Barclays Plc.

“We should be seeing some strong contributions from Kentz when oil prices rebound,” Moss said. “These guys can do something special over time. It’s just going to take a little while because they are going to have to move through some of their problem contracts.”

Before it's here, it's on the Bloomberg Terminal.
LEARN MORE