McDermott International (MDR) is down over 33% year to date and down nearly 90% from its all time high in 2008. Is there any hope for this oil/gas engineering and installation company? The company is now trading below book value, and the last time this happened the stock went on a 600% tear upwards, from 2009 to 2011.
Will we see this kind of tear again? It's hard to say, but we like to look at the unloved stocks. We believe in MDR for the long-term, we're talking five plus years. The first thing that jumped out to me? The company has nearly $2 per share of cash, which means nearly 30% of its market cap is covered by cash. What's more is the company has a net cash position of $360 million (cash is greater than debt).
McDermott is well positioned in the fast growing offshore energy markets, with an impressive presence in most of the major offshore producing regions, including the U.S., Canada, Mexico, the Middle East, India, the Caspian Sea and Asia Pacific.
Most recently, the stock has tumbled nearly 20% over the past month after another abysmal quarterly release. One of the big overhangs is continued restructuring charges. After a number of key executives retired, McDermott initiated a restructuring strategy that is expected to cost between $45 million to $60 million.
Restructurings always makes investors a bit uneasy, because corporations of this size are not always clear about what is actually wrong or needs to be changed. We believe the changes will be fruitful and not something a consulting firm has pulled over their eyes.
Another horrid quarter
Let's get into some of the details of this abysmal quarter that forced the stock down some 20%. MDR reported a loss of $63 million for 2Q 2013, namely due to continued restructuring charges. Another big piece of news is the 2014 outlook. MDR has reiterated the fact that its '14 operating margin target is 5% to 8%, compared to previous expectations of 10%. As for performance in its specific segments...
- The Atlantic segment saw revenues up to $186.6 million, or 69% growth year over year, thanks to fabrication activity in Mexico. But the segment saw an operating loss of $48.7 million, including a $15.5 million restructuring charge. Excluding this, the segment loss was $33.2 million. The charge was related to relocation of Morgan City's fabrication and marine activities to Mexico. On a more normalized basis, the Morgan City move is expected to save the company some $10 million to $15 million on a quarterly basis. On a positive note, the company believes that the Atlantic segment could break even by the end of 2014.
- Revenues in Asia were down 32% year over year, leading to an operating loss of $32.4 million. This included a $62 million charge related to its Malaysia project. The project was booked at $250 million, and how has $190 million left to go. Adding back the $62 million charge and operating income was a positive $29.6 million.
- Middle East revenues were $230.9 million, up 478% year over year, driven by new projects primarily in Saudi Arabia and the Caspian Sea. The segment, however, saw an operating loss of $68.5 million, which included a $38 million charge for a project in Saudi Arabia.
However, there are tailwinds...
Record backlog. MDR ended 2012 with a record backlog of $5 billion. With a down year in 2011, MDR has surged back to surpass the previous record set in 2010. The Supermajors (Chevron, BP, Conoco, etc) are looking for the big projects off-shore to boost their valuations and MDR is proving to be key in helping them.
Re-entry to sub-sea. In 2012, MDR won a contract for a subsea project that was the largest project to date, in the world, and is estimated to be a $2 billion deal over the life of the project. Considering MDR wasn't very active in the subsea construction market prior to this project, it's very encouraging to see them land this.
Future pipeline. The construction business, particularly a niche construction industry, is based upon current and potential backlog. We already mentioned that they set a company record for backlog in 2012, but it's also worth pointing out that, in addition to its backlog, MDR has a hand in $18 billion worth of projects through bids or target projects. There is never a guarantee of winning bids, but you have to put your hat in the ring in order to win anything and they have done well lately, so we expect more to come.
All in all
Given this is a "long-term" investment; we'll take the long-term perspective when it comes to putting the valuation in perspective. The 2013 EPS estimates are for $0.86, and if we put a annual growth rate of 16% (Wall Street estimates) for the next five years, the 2018 EPS should come in around $1.80.
In trying to determine a fair P/E multiple, it's tough to use peers, as major drillers Schlumberger, KBR and Oceaneering, trade anywhere between 15x to 35x. Thus, we turn to the historical multiples. Over the past five years, MDR has traded with at an average of 14x earnings, and 16x over the past ten years. Thus, we feel it's safe to use a 15x P/E. Putting a 15x P/E on 2018 EPS estimates assumes a $27 price target, or 275% upside -- annualized returns of 30%.
Like I said, I'm looking at McDermott as a long-term investment choice. The company is undergoing restructuring and re-shuffling executives, both of which are positives for securing new bids and repositioning itself as an industry leader, the biggest question is how long will it take? There is plenty of doubt about the company, but now might be a good time to accumulate the stock for cheap, trading at less than 13.5 times forward earnings, trading for less than book value and having a $5 billion backlog.