McDermott International (NYSE:MDR) is an engineering, procurement, construction and installation [EPCI] company engaged in designing and executing complex off-shore oil and gas projects worldwide. The company is one of the largest U.S. based engineering and construction companies exclusively focused on the upstream off-shore oil and gas sector. Moreover, the company provides full integrated EPCI services as it delivers fixed and floating production facilities, pipeline installations and subsea systems from concept to commissioning, with a diversified fleet of marine vessels, fabrication facilities and engineering offices around the globe.
McDermott has had a bad reputation regarding meeting earnings estimates during the last few quarters and reported missed revenues and earnings estimates during the period. The prime reasons for shortfall are the decreasing order backlog, increasing cost of operations and the pressure faced by the off-shore drilling industry, which has resulted in lower contracts wins by McDermott. Further, the company has suspended its practice of issuing earnings guidance, which has had a negative impact on the investor perception and resulted in severe stock price depreciation in the event of any underperformance by the company. The stock fell over 16% during the last year and it is further down over 16% year-to-date.
McDermott is one of the largest amongst its industry peers and provides full integrated EPCI services in approximately 20 countries across the globe from Asia Pacific, Atlantic, and Caspian to the Middle East. The company also supports its operational revenues with comprehensive project management and procurement services. Further, the company operations are generally capital intensive in nature and rely on large contracts, which accounted for a substantial amount of company revenues over the last few years. Moreover, the McDermott's operations depend heavily on capital expenditures for off-shore construction services of major integrated oil and gas companies and national oil companies for the construction of development projects.
Business Performance and Overview
McDermott faced severe operating losses over the last year which is mainly due to the decreased order backlog during the period. The revenues fell by 27% to $2.66 billion compared to $3.64 billion in the same period last year. This decrease is mainly due to a combination of operational issues including impairment of balance sheet assets, and commercial issues with customers that impacted the estimated costs for various projects of the company.
Source: SEC Filings
The fall in revenue and the increased losses of the company over the last year are also due to the poor segmented performance. Asia Pacific, Middle East and the Atlantic segments faced losses of $62.2 million, $174.4 million and $78.5 million, respectively during the last year. The progress on several ongoing projects has already been suffering due to excessive costs incurred - these costs have escalated due to harsh climate and weather issues. These delays and increased costs will result in further losses for the company.
Despite the decreasing backlog in the last year, the company reported significant growth of over 67% from its Middle East region. This increase is due to increased customers' revenues from the region, mainly from Saudi Aramco which contributed around 25% of the consolidated customers' revenues during the last year.
Source: SEC Filings
Second Quarter Earnings
McDermott recently announced its second quarter earnings and reported an improvement in earnings. The company reported a second quarter net loss of $11 million, compared to loss of $149 million in the same period last year, per share loss stood at $0.05 compared to $0.63 second quarter of the last year. However, the revenues for the period went down to $476 million, 26% lower than the revenues of $647 million in the corresponding period last year, which is mainly due to lower marine contribution in the second quarter.
Source: Company Website, Second Quarter Earnings Release
Also, the company's backlog was $4.1 billion, down 7% compared to $4.4 billion in the same period last year. The major portion (61%) of the order backlog is for the subsea operations while the remaining 39% is for the off-shore operations of the company.
There have been concerns about the off-shore sector due to the major oil and gas companies reducing capital expenditures. However, despite these fears, the companies have been spending about 50% on off-shore developments. Countries like China, Brazil, Japan, India, Nigeria, Thailand and even the U.S are focusing on developing off-shore assets as the on-shore reserves continue to deplete at a faster pace. We have seen considerable increase in activity in the Gulf of Mexico and off-shore Africa. As the off-shore assets are being developed, the off-shore infrastructure companies will benefit heavily.
McDermott will benefit heavily mainly due to the heavy operational concentration in the international markets where demand for off-shore oil and gas services and construction remains strong. McDermott generated over 95% of its revenues from projects outside the U.S. Moreover, the company's international operations are highly influenced by the worldwide oil and gas demand which remained strong over the last few months. This increased demand will likely keep the commodity prices strong and prompt the major oil and gas companies to increase the capital expenditures.
Further, the offshore EPCI market is also set to grow better in the future due to the continued growth in deep-water developments. As a result of expected demand rise, the company has two vessels under construction: LV-108, a multi-service vessel intended to be used in Middle East, and DLV-2000, a pipelay/derrick type vessel intended to serve the Asia Pacific segment of the company. The recent contract win by Seadrill (NYSE:SDRL) for its newbuild, West Saturn, shows that the demand for the off-shore equipment remains strong. It is fair to assume that the company will be able to employ its vessels as these vessels are delivered.
The price performance of McDermott has been quite poor over the last one and half year, and the company is not out of trouble. The revenues continue to fall along with the falling order backlog. Middle East is one of the most important regions for the company which continues to be unstable and the capital expenditures in other regions by major oil and gas companies remain slow. McDermott might have to weather this storm for a little longer and the short-term prospects of the company do not look good. However, in the long-term, we believe the off-shore drilling sector has a lot of potential and the slowdown in CapEx from the major oil and gas companies is also short term. We believe McDermott can yield good results for the patient investors.
Additional Disclosure: This article is for educational purposes only and it should not be taken as an investment recommendation. Investing in stock markets involves a number of risks and readers/investors are encouraged to do their own due diligence and familiarize themselves with the risks involved.
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