WOR needs to deliver on its promises. If it can, we see...

WOR needs to deliver on its promises. If it can, we see substantial
upside. If it can't, downside looks limited in all but the bear case. We
retain our Overweight rating.

What's Changed? From To
Price Target    A$7.17 A$6.35
Time to step up. WOR's recent operating performance can only be described
as poor. Over the last three years the business model has failed to work in a
downturn (margins should rise as costs are cut ahead of the curve and cash
flow should be countercyclical) despite rigorous restructuring. The business is
capable, as we have seen with similarly structured peers, it is execution that
has fallen short. Investor confidence is low, however, a recent change in CFO
and unusually for WOR, specific guidance on further cost out and cash
recovery, gives scope that WOR might finally deliver.

Cutting hard. WOR is taking the right steps to get the business model to
work. The problem looks to lie in WOR's overhead structure (staff have fallen
by ~29% from peak, ahead of a ~17% fall in revenue and utilization is trending
upward). WOR now plans to cut another A$180m of overhead. Eventually, this
action should deliver a positive margin result, as peers have shown. Still, given
WOR's track record, we don’t assume delivery in our base case. We cut
underlying EPS forecasts across FY16-18 by 4-12% and assume WOR recovers
~A$260m of cash (versus A$300m targeted) over the next 18 months.

What if it doesn’t work? With ND /EBITDA at 2.5x at 1H16, WOR's capital
position now dominates any investment discussion. WOR believes it can
recover A$300m of cash (capex cuts, working capital and non-core asset sales)
which may be conservative given WOR's DSO reduction target alone could
free ~A$400m. Investors however are likely to place little faith in this
commentary and instead focus on what could go wrong. Our stress test (which
assumes a covenant at 3.5x) suggests WOR could still absorb some
combination of materially lower underlying earnings, further cash outflows
and a lower AUD/USD over FY16-17e. However, if all of WOR's plans were to
fail, an equity raising may be required (as captured in our bear case).

Risks have increased. The risk profile of WOR stock has increased, but
trading at a 43% one-year forward P/E discount to global peers, a failure to
deliver is arguably already priced in. With aggressive cost and cash action now
being taken, we still believe risk is skewed to the upside with any material
recovery of cash in FY16-17e (as WOR plans) expected to close the valuation
gap to peers and drive the stock toward our price target.

Investment Thesis
WOR is our preferred play on the E&C subsegment
of the industry. It has the least exposure
to the deteriorating Australian market, and we
believe that hydrocarbons capex will recover before
metals and mining capex.

The current share price appears to be pricing in a
bearish earnings scenario into perpetuity.

WOR continues to undertake restructuring to
right-size the business in response to capex cuts in
the hydrocarbons sector.

Key Value Drivers
Hydrocarbons capex – WOR earns 70% of its EBIT
from hydrocarbons.

Working capital assumptions influence cash-based
valuations (1% shift in terminal year lowers our
DCF valuation by ~0.5%).

Oil price – although there is no direct connection,
WOR has shown some correlation to the oil price

Potential Catalysts
Contract wins – visibility of upcoming wins remains
poor, but given underlying momentum any
additional contract wins will be well received.

International peer outlook commentary.
WOR delivers targeted cash recoveries

WOR's cost our program results in a positive
inflection in margins

Risks to Achieving Price Target
Macro downturn.

Shifts away from EPCM project model.

Sustained fall in oil prices and capex cuts from
customers.

Continued project delays.

WOR fails to improve underlying earnings and
cashflow despite significant restructuring costs and
asset sale initiatives

… what if WOR can deliver on cash flow but not earnings - EBIT would need to fall ~37% below our
base case in FY17e
An alternative, but still negative scenario, would see WOR recovering the cash it is targeting but that its
restructuring efforts are not enough to prevent a further fall in earnings below our forecasts. This scenario
implies that WOR's underlying EBIT would have to decline to ~36% below our FY17e base case before reaching
ND/ EBITDA of ~3.5x.

It's also worth considering - could cash recovery exceed expectations?
Equally, a scenario where WOR generates more than A$300m of cash by the end of FY17e is not implausible.
Against a ~A$2.1bn receivables balance, WOR's targeted reduction in days sales outstanding (DSOs) from ~80
days to ~65 days alone implies a ~A$400m cash inflow. Equally, the underlying business should generate cash.
Even assuming much weaker earnings than our base case, poor cash conversion and more restructuring costs,
the business should be capable of generating >A$100m of gross cash flow. Any asset sales would contribute
cash above these levels. On a net basis, with dividends suspended, only underlying capex would need to be
deducted from these figures.