Fluor: A Solid Large Cap With Big Appreciation Potential

| About: Fluor Corporation (FLR)

Fluor Corporation (NYSE: FLR) is a century-old professional services company that provides engineering, procurement, construction, maintenance, and project management services to a wide array of industries around the world. Clients include many of the leading companies in the oil and gas, chemicals and petrochemicals, mining and metals, manufacturing, and transportation sectors. It's also a leading service provider to the U.S. government. Fluor, which is consistently ranked one of the world's most admired and ethical enterprises, offers a broad range of services and has the capabilities to operate in some of the harshest far-flung corners on earth. The multinational concern benefited greatly from the socioeconomic and population trends that reshaped the face of the globe over the past two decades. More importantly, these same trends -- growing population, rising wealth, continued urbanization, and increasing demand for all sorts of products and commodities, etc. -- promise to keep Fluor's top and bottom lines ascending for years to come.

Revenues and earnings have moved strongly upward for some time. Revenues per share, for instance, compounded at a 10.7% rate over the past 10 years, while share net rose at an even faster clip, rising at a 14.9% annual rate during this period and reaching $4.28 in 2012. Fluor's impressive track record and solid reputation is reflected in both a top-notch balance sheet and the booking of $27.1 billion in new awards last year; as of March 31, 2013, the balance sheet held $2.2 billion in cash and equity of $3.6 billion, while debt totaled a modest $514.7 million. The new awards, which lifted the backlog to $38.2 billion, provide a good foundation for continued revenue growth and prosperity. Looking forward, a slowdown in the mining and government businesses, along with some margin pressures, suggest 2013 earnings could dip from last year's record-setting tally, but the intermediate- and long-term future looks quite rosy. Significantly, too, Fluor generates considerable free cash flow (cash left after meeting dividend and capital expenditure requirements), which affords management considerable flexibility in terms of share repurchases, and perhaps boosting the very low dividend payout ratio (mid-teens); 7.4 million shares were bought back in 2012 and a February 6th board authorization to repurchase eight million more shares lifted the number of shares available for repurchase (as of that date) to 11.8 million shares.

Fluor stock's performance has been relatively subdued thus far in 2013. As such, the good-quality shares look inexpensive on a historical basis, unlike many of the higher-quality stocks that have rallied so strongly of late in celebration of the Federal Reserve's extended cheap-money policy. At Friday's (June 14, 2012) closing price of $61.00, FLR shares trade at 14.7-times our $4.15 earnings estimate for 2013 (and just 13.1-times our figure for 2014). For some perspective, over the past 15 years, the P/E ratio has ranged from a low of 12.3 to a high of 34.1. The annual average is 22.9, and it was north of 20 in nine of those years. The low end of the range was hit in 2009, the year that the stock market plummeted to multi-year lows. We think the stock will about double in price over the next three to five years, even assuming only a modest expansion in the multiple. The mid-point of our relatively wide $100-$145 price targets is $122.50, which assumes revenues, operating margin, tax rate, diluted share base, and per-share earnings of $38.9 billion, 4.4%, 30.5%, 148.0 million, and $6.80, respectively.

The Company

Fluor Corporation is one of the world's leading providers of engineering, procurement, construction, maintenance and project management services. Although incorporated on September 11, 2000, prior to a reverse spin-off of its coal operations to Massey Energy Corporation, the Irving, Texas-headquartered company traces its origins to its founding in the late 1800s by John Simon Fluor, a Swiss immigrant. The multinational concern, with some 41,200 employees operating in 73 countries, serves a diverse set of industries worldwide, including oil and gas, chemicals and petrochemicals, transportation, mining and metals, power, life sciences and manufacturing. It's also a primary service provider to the U.S. federal government.

Fluor offers a full range of services through five principal segments - Oil & Gas, Industrial & Infrastructure, Government, Global Services, and Power. This diversified model and global reach allows it to undertake complex megaprojects from concept to completion. The company secured $27.1 billion in new contracts last year ($26.9 billion in 2011) and ended 2012 with an aggregate backlog of $38.2 billion, compared with $39.5 billion at the end of 2011. Of the total, 85% (or $32.6 billion) were comprised of "cost reimbursable" contracts, under which the client reimburses Fluor for its costs in performing a project and pays a pre-determined fee, which essentially represents the company's profit. The balance consisted of "fixed-price, lump-sum, and guaranteed maximum" contracts. For 2012, BHP Billiton (NYSE:BHP) was the most significant client, accounting for 13% of overall revenues. The U.S. government and Exxon Mobil Corporation (NYSE:XOM) were next, with 12% and 11%, respectively. Approximately 75% (or $28.8 billion) of the consolidated backlog related to projects located outside of the United States.

Oil & Gas (34.5% of 2012 revs, 28.2% of op. profits)

The Oil & Gas (O&G) segment provides engineering, procurement, construction and construction management services for some of the largest and most complex upstream, downstream and petrochemical projects in the world. It designs and builds processing plants, refineries, pipelines, offshore facilities and other energy assets in remote and challenging locations around the globe. Fluor also provides consulting services, ranging from feasibility studies to process assessment to project finance structuring and studies.

Segment revenues increased almost 20% in 2012, buoyed by higher project execution activities for several projects, including a coal bed methane gas project in Australia, a grassroots petrochemical complex in the Middle East, and a major mine replacement project in Canada; they were up a mere 3% in 2011. Operating profits, meanwhile, essentially kept pace with the revenue advance, increasing 21% (to $335 million), as margins stayed virtually unchanged.

Importantly, the O&G business witnessed a 52% surge in new awards last year, booking contracts worth $12.6 billion, which lifted the segment's backlog to $18.2 billion (versus $15.1 billion at the end of 2011). The new awards included an oil sands bitumen process facility in Canada, a gas processing project in Kazakhstan, and a petrochemicals complex in the United States. Ongoing trends in the global economy that call for increased oil, gas, and chemical supplies -- up, mid-, and down-stream -- is dove-tailing well with Fluor's versatility and reach, as are the emerging, significant conventional and unconventional hydrocarbon (oil sands and shale) opportunities in both the U.S. and Canada. The O&G segment accounted for 47% of all new orders secured in 2012.

Industrial & Infrastructure (44.2%; 45.6%)

The Industrial & Infrastructure (I&I) segment provides design, engineering, procurement, and construction services to the transportation, wind power, mining and metals, life sciences, manufacturing, commercial and institutional, telecommunications, microelectronics and healthcare sectors all over the world. Fluor's focus is on providing its clients with solutions that reduce/contain costs and compress delivery schedules. In transportation, for example, as the global population continues to grow and existing infrastructure continues to age, the company provides a broad range of services, targeting large complex projects that might include the development of roads, highways, bridges, and railways. In mining and metals, the services provided might include feasibility studies through detailed engineering, design, procurement, construction, and commissioning and start-up support, with the capability to pursue projects in the most challenging environments in the world, including the Andes Mountains, Mongolia, and Western Australia. In life sciences, the company offers a full range of services to the pharmaceutical and biotechnology industries.

Segment revenues increased 26% in 2012, reaching $12.2 billion, after soaring 41% in the previous year. The gains were fueled by growth in the mining and metals businesses. Excluding two nonrecurring items, netting out to a pre-tax charge of $373 million, operating profits increased roughly 28%, to $497 million; the big item was a $416 million charge in the year's final quarter, related to an unfavorable arbitration ruling in efforts to receive additional compensation on the $1.8 billion lump-sum Greater Gabbard offshore wind farm project.

Unlike the O&G segment, though, the I&I segment experienced a relatively sharp drop in new business last year. New awards dropped to $9.5 billion in 2012, compared with $12.2 billion and $12.5 billion in 2011 and 2010, respectively. As a result, the segment concluded the year with a backlog of $15.5 billion, 21% below the year-earlier total. The deterioration of late is attributable to the deferral of major capital investments by some mining customers, which are hurting from cost escalation, softening commodity demand, and project-specific challenges. Significantly, macroeconomic conditions suggest these issues could linger for a while.

Government (12.0%; 12.6%)

Fluor's Government segment provides logistics services, base and facilities operations and maintenance, contingency response, and environmental and nuclear services support to the U.S. government, which is the single largest purchaser of outsourced services in the world. It's primarily focused on the Department of Energy, the Department of Defense, and the Department of Homeland Security. For the Energy Department, services provided include site management, environmental remediation, decommissioning, engineering, and construction services. And for the Defense Department, the company helps support the hundreds of thousands of troops deployed overseas; provides remediation services for aging nuclear facilities; and aids in the operation and maintenance of military bases. Finally, this segment supports the government's rapid response capabilities to address security issues and disaster relief.

Revenues decreased slightly in 2012, slipping 2.8% (or $93.5 million) to $3.3 billion, hurt by the evaporation of stimulus money that had funded work at the Savannah River Site Management and Operating Project in South Carolina; they had increased 12% in 2011 due mainly to work supporting the U.S. army in Afghanistan. Segment profit increased 2.9% to $149.7 million, however, as operating margin expanded by about 20 basis points (to 4.5%).

Top-line contributions will most likely drop further this year, as new awards dropped considerably in 2012, falling from $3.7 billion in 2011 to $3.2 billion. The decline is attributable to a reduction in LOGCAP IV new award activity that reflects, in part, less funding for the Portsmouth Project, for which 2011 was the initial year. The backlog at the end of last year was $978 million, representing just 2.6% of the company's total. By comparison, the backlog at the end of 2011 was $1.1 billion.

Global Services (6.2%; 15.0%)

The Global Services (GS) segment provides a wide array of solutions to help industrial clients optimize the performance of their plants and facilities. The unit's 13,000 skilled personnel offers facility management, site-based maintenance, plant engineering, industrial fleet and equipment services, small capital construction, and temporary professional staffing, frequently working in conjunction with workers from other Fluor segments. In fact, this business often benefits from large projects that originate in other segments, which can lead to long-term maintenance or operations opportunities, or vice-versa. Activities in the operations and maintenance markets include providing facility start-up and management, plant and facility maintenance, operations support and asset management services to the oil and gas, chemicals, life sciences, mining and metals, consumer products and manufacturing industries.

Segment revenues rose a healthy 9.1% in 2012, driven by increased equipment business in South America, Mexico, and Canada. Improvements in the operations and maintenance, temporary staffing, and supply chain solutions business lines helped, too. This high-margined segment's profit contribution increased by an even more impressive rate, rising 17% to $177.6 million, aided by 0.7 percentage point expansion (to 10.3%) in the operating margin; the margin improvement was most notable in the operations and maintenance (O&M) business line.

New awards in the Global Services segment fell to $904 million, though, from $1.0 billion during 2011 and $1.6 billion during 2010, hurt mainly by both persistent problems in getting existing clients to renew O&M contracts and delays in securing new clients. As such, the backlog eased again, falling to $1.7 billion, from $1.9 billion in 2011 and $2.1 billion at the end of 2010.

Power (3.0%; loss of $16.9 million)

The Power segment provides a full range of services to the gas fueled, solid fuels, environmental compliance, renewables, nuclear, and power services markets. Services include engineering and design, procurement, construction, program management, start-up and commissioning, operations and maintenance and technical services.

Significantly, the power markets currently face significant headwinds as the government focus on renewables is limiting the types of capital projects owners can undertake. As well, the absence of definitive clean energy policy and compliance legislation for emissions standards is causing uncertainty and hesitation for spending. On the flip side, booming production in North American shale gas is holding natural gas prices low and generating opportunities for the Power group.

Revenues in 2012 were 13.1% higher than in 2011 but 50.4% lower than in 2010, reflecting both the completion, or near completion, of several power plant projects and the relatively weak demand for new power generation. The deterioration has been even worse when it comes to profitability, with operating income falling from $170.9 million in 2010 to $81.1 million in 2011 to a loss of $16.9 million last year. Decreased contributions from several completed projects have certainly hurt, as have increased expenses stemming from investments in NuScale Power, a small modular nuclear reactor technology concern that Fluor acquired a majority interest in late 2011. New Power awards totaled only $884 million in 2012, down from $1.6 billion in 2011. The backlog was little changed at the end of last year, at $1.9 billion, versus $1.8 billion.

Big Picture Dynamics

There are more than seven billion people on the planet. The population is growing constantly and is increasingly congregating in urban areas. These trends foreshadow the continued development of massive infrastructure (bridges, roads, buildings); substantial increases in worldwide demand for energy, requiring critical innovation in all sorts of fuel sources (hydrocarbon, nuclear, solar, wind); and colossal projects, in terms of materials and manpower, to produce the commodities necessary to enhance the world's standard of living. New technologies are facilitating the accommodation of these needs, allowing for example, the development of North America's vast shale gas resources, which could make the United States energy independent and provide low-cost feedstock. Technological advances also allow for commodity extraction in deeper and deeper waters, as well as ever harsher environments. Significantly, Fluor's versatility and global reach, along with its long-standing relationships with many of the largest operators in the world that will be integral in meeting the challenges of a growing population, strongly suggest that the Texas-based concern will be a key beneficiary of the large secular trends. This is manifested, in part, by the company's $27.1 billion in new awards secured in 2012, despite a global economy that can best be characterized as sluggish.

Solid Track Record

Revenues dropped sharply in the year after Fluor spun off the Massey coal business in November 2000. The top line has ascended strongly in the past 10 years, however, with per-share revenues compounding at a 10.7% annual rate through 2012. Indeed, aggregate revenues almost tripled during this period, rising from just less than $10 billion in 2002 to $27.6 billion last year, supported by vigor in most of the company's diverse businesses and growth across a broad spectrum of geographies. Other measures of the company's performance are even more impressive, with per-share cash flow, earnings, and book value each rising by more than 14% annually (14.2%, 14.9%, and 14.2%, respectively). Importantly, the prosperity metrics were enhanced by an appreciable expansion (roughly one percentage point) in the operating margin, reflecting decent operating leverage inherent in the business model. They were also helped by declines in both the effective tax rate and the number of shares outstanding.

Good Three- to Five-Year Prospects

Fluor reported March-quarter financial results that were both considerably above last year's tallies and better-than-expected by Wall Street. Revenues were up 14.2% (at $7.2 billion), year over year, mainly due to an astounding 35.7% surge (to $2.8 billion) in contributions from the Oil & Gas segment. The I&I and Power segments also posted some year-over-year gains, but revenues were down in the Government and Global Services businesses. Earnings per share, meantime, rose 12.1% to $1.02; Wall Street's consensus estimate was $0.96. A highly competitive environment is squeezing margins, but the company was able to mitigate the bottom-line impact through stock repurchases that reduced the diluted share base by 3.8%.

Looking ahead to the balance of 2013, the recent slowdown in the mining and metals business, after four years of rapid growth, along with the potential impact of the federal government's budget sequestration, strongly suggest that earnings could dip slightly for the full year; consolidated new awards in the first three months were $6.5 million, considerably below the $8.4 billion secured in last year's comparable period. All in all, we think share net will approximate $4.15, which is towards the high end of management's guidance of $3.85 -- $4.35. (Note: NuScale is expected to shave about two dimes from per-share profits.)

Looking further out, we think Fluor's global reach, project expertise, and strong client relationships position the company superbly to benefit from the large secular trends described above. Indeed, it's likely to be a primary beneficiary of the potentially game-changing North American energy infrastructure cycle. A recently secured oil and gas contract in Kazakhstan augurs well for the future, as do two contracts to support Reliance Industries' refinery and petrochemical projects in India. Also noteworthy are new awards for additional work at a major oil sands expansion project in Canada. Significantly, too, despite the slowing demand for commodities of late, Fluor has won a number of important mining and metals contracts, including, most notably, a leadership role in Barrick Gold Corporation's (NYSE:ABX) Pascua Lama mining project on the Argentina/Chile border, perhaps one of the most challenging mining projects now underway in the world. All things considered, including the strong likelihood that excess cash flow will support the continued repurchase of FLR stock, the company should be able to keep the bottom line ascending at a double-digit rate well into the current decade.

No Free Lunch

Needless to say, Fluor, like all companies of its size, scope, and geographic participation, is subject to a whole host of risks and uncertainties. At the macro level, it is sensitive to global economic conditions, as they affect the company's client base, partners, subcontractors, and suppliers. Indeed, the myriad uncertainties that have shrouded many of the world's economies have reduced Fluor's clients' willingness to fund various projects, unable to accurately forecast and plan future business trends and activities. The prevailing business conditions also influence the already competitive global engineering, procurement, and construction sector, with implications on market share and profit levels. On a more micro level, the company is vulnerable to the cyclical nature of the many markets that it serves. As well, considering its position as a major provider of outsourcing services to the U.S. federal government, the nation's dire financial health is clearly a source of some concern. Furthermore, Fluor's substantial international operations, including in many of the lesser developed (economically and politically) countries, expose the company to various economic and political uncertainties. These include the risk of asset seizures, terrorist attacks, project disruptions, and adverse changes in currency exchange rates; as of December 31, 2012, some 75% of the company's business backlog consisted of revenue to be derived from projects and services to be completed outside the United States. And in this regard, it should be noted that the various contracts that make up the backlog are subject to unexpected adjustments and cancellations.


A relatively sluggish global economy is certainly a concern, given the varying sensitivity of Fluor's client base to general business activity. Indeed, capital spending on the large projects that can move the needle has slowed, most notably in the mining and minerals sector. Fiscal constraints at the federal government are a concern, too, as it's also an important source of revenues. The larger secular trends described above will undoubtedly hold sway over the long haul, however, auguring well for Fluor, with its expansive client relationships, expertise gained through a century of experience, global diversification, and substantial financial standing. Per-share earnings compounded at a healthy double-digit annual rate over the past 10 years, and the same seems likely through the latter part of this decade. All things considered, we think these shares offer very attractive capital appreciation potential over the long haul. As a final note, we would point out that our 3- to 5-year projections assume far fewer share repurchases than the company could probably afford.

Disclosure: I am long FLR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.