Shareholders of FTSE250 Specialist for energy services Wood group (LSE: WG.) have had a rough time in recent years. In July, hopes were high that a 230p offer from Dubai-based rival Sidara could provide a profitable way out of a difficult turnaround.

However, the offer failed on August 5, when Sidara decided not to make a firm offer and “geopolitical risks and uncertainty on financial markets”.

This situation has put CEO Ken Gilmartin under renewed pressure. However, Wood’s recent half-year results lead me to believe that a real recovery is underway. If Gilmartin can achieve his goals, my analysis suggests the stock may be too cheap at current levels.

Performance improves

There is an old stock market saying that goes: Sales are vanity, profit is reason and cash flow is realityThis means that sales (revenue) can be easily increased if you are not too concerned with making profits.

Gilmartin is wisely resisting the temptation to increase sales through risky, low-reward work, and instead is focusing on improving profit margins and cash generation. This should make Wood Group a better quality company.

The company’s half-year results suggest to me that it is making progress. Although revenue fell 4.8% to $2,844 million compared to the first half of 2023, adjusted operating profit for the half increased 14.2% to $102 million. Cash flow from operations also increased 29.3% to $51 million on an adjusted basis.

The Wood Group has not yet reached the point where it generates excess cash to fund debt payments or dividends, but it is getting closer.

Gilmartin left its financial targets for 2024 and 2025 unchanged at the half-year mark and expects “significant free cash flow” in 2025.

Why it might be too cheap

Broker forecasts I have suggest that Wood Group could generate cash surplus of $136 million in 2025. Comparing this estimate with the company’s market capitalization of £925 million gives me a forecast free cash flow yield of 11%.

As a rule of thumb, I would consider anything above 6% potentially cheap. But there is a catch. Wood Group has more than $1 billion in net debt. That’s a bit too much for my taste. If the company hits its free cash flow targets, I expect a lot of that money to be used to pay down debt. It could take longer to return to paying dividends.

However, the company’s debt problems are no secret. They are one of the reasons why the stock is trading more than 40% below its book value, which I estimate at 245 pence per share.

If Gilmartin Woods can get profits back up and reduce debt, I think the share price could rise back to the 245p level. Based on a current price of 135p, that would turn 55p invested today into 100p.

The story continues

What I would do now

Wood Group still faces a challenge to turnaround and its backlog could shrink if oil and gas markets weaken. Debt remains a risk, at least for now.

The company also has nearly $300 million in legacy liabilities related to asbestos damage compensation payments, which are expected to last until at least 2050.

However, I think most of the risks are now reflected in the share price. If Wood Group’s recovery continues as expected, I think the stock could perform well from current levels.

The post Why this unloved FTSE 250 share could turn 55p into at least £1 appeared first on The Motley Fool UK.

Further reading

Roland Head does not own any of the stocks mentioned. The Motley Fool UK does not own any of the stocks mentioned. The views expressed in this article about the companies mentioned in this article are those of the author and as such may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool, we believe that considering a diverse range of insights makes us better investors.

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