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McDermott Intl. (NYSE:MDR) has three main businesses. BWX Technologies is the sole supplier of nuclear fuel assemblies to the U.S. Navy. Babcock and Wilcox manufactures environmental equipment, boilers and other parts and services for utility companies. And, the J. Ray McDermott division provides marine construction to customers in the offshore oil and gas industries.

2007 through mid-year 2008 proved to be the high water mark for EPS for MDR as oil prices stimulated E&P worldwide. EPS peaked at $2.66 in 2007 with MDR shares hitting an all-time high of $67.14 this past June. With oil prices falling back, these shares have tumbled to just over $8 despite current consensus estimates of $2.12 and $1.91 for 2008 and 2009 respectively.

Momentum investors have bailed out, leaving these shares at less than 4.4x next year's already reduced estimate. That's the lowest P/E in over 15 years on these shares. It's also the lowest absolute dollar price (excepting the past few weeks) since early 2005, when full year EPS came in at $0.66.

McDermott has a strong balance sheet. Total debt was only $13 MM at mid-year 2008 versus cash holdings of over $1 billion. Total interest coverage is more than 25x. Book value is approximately $7/share.

Insiders have been snapping up the shares. Since November 10th, five separate insider purchases were reported at prices from $6.45 to $10.29 per share. There were no reported insider sales since July and August and those took place at prices of $47.83 to $60.83.

Patient investors could see a huge run up in price from yesterday's quote. The peak prices in each calendar year 2005 – 2008 were $15, $26.70, $62.80 and $67.14 respectively. Even eight times next year's $1.91 estimate would bring these shares back to $15.28 or + 84% from here.

Want a nice 13 ½ month option play?

…………………………………….....……….Cash Outlay……..Cash Inflow

Buy 1000 shares of MDR @ $8.30 ……….. ($8,300)

Sell 10 MDR Jan. 2010 $10 Calls @ $2.75 ……………………. $2,750

Sell 10 MDR Jan. 2010 $10 Puts @ $4.10 ……………….……. $4,100

Net Cash Out-of-Pocket …………….……… ($1,450)

If MDR shares are greater than $10 on expiration date in January 2010 (a gain of 20.5% from your starting point):

Your $10 calls will be exercised and the shares sold for $10,000.

Your $10 puts will expire worthless (a good thing for you - the seller).

You will be left with no shares, no option obligations and $10,000 cash for your original $1,450 cash outlay. A very nice gain.

Worst case you would end up owning 2000 shares of MDR.

The original shares plus the exercised $10 puts (with a net cost of $10 less the $4.10 put premium) = $5.90/share.

What's your breakeven on the whole trade?

On the shares you bought at $8.30 it's that price less the $2.75 call premium or $5.55 /share.

On the "put" shares it's the already calculated $5.90 /share.

Your 2000 shares would have an average cost of $5.73 or 31% below the $8.30 starting price.

Disclosure: Author owns shares and is short puts on MDR.

Source: McDermott International: A Triple Play that Might Score