McDermott International (NYSE:MDR) is doing exceptionally well in a challenging market. It has been successful in winning new contracts and extensions to its current agreements when other vendors have been facing cancellations. Companies in this sector of the oil and gas industry rely heavily on the capital spending by the oil and gas companies. We can say that the revenue of these companies and the capital expenditure by oil and gas companies is usually positively correlated. As the capital expenditures increase the demand for their services also increases. However, over the last two years, the E&P companies have been consistently reducing their capital spending in order to ride out this low commodities environment. Despite these market conditions, McDermott has been able to add to its order backlog.
During the second quarter, the company added $1.2 billion to its already impressive backlog of $3.2 billion. Currently the backlog stands at $4.4 billion. This means that the revenue visibility for the next two years is clear. Most of this backlog will be used up during the next year as some contracts are being operated on priority basis in the Middle East and Australia. Before the announcement of the second quarter earnings, the company announced another agreement in Qatar. This further strengthens its position in the Middle East. Strong rapport with the national oil companies (NOCs) has been the key reason behind McDermott's success in adding to its backlog.
Oil and gas economics differ for the countries that are dependent on these commodities for their budgeting needs. NOCs do not usually face the dilemma of limited cash and the cost and benefit conundrum of increased production. If the prices are falling, the chances are that an NOC will increase its production to make up for the lost revenue. Existing wells can grow production to an extent, but if the low price environment remains for an extended period, these companies will need to drill more. This is what is happening now in the Middle East. Saudi Aramco is now the second largest customer for McDermott and it has been present in Qatar for a long time. We will see further investment from Qatar as the country has not made efforts in the past to develop new fields. Australia will become a huge threat to Qatar due to its aggressive expansion plans and LNG exports. Qatar has not been aggressive in developing its assets and it will need to put in more investment.
Cash flows are also getting better. McDermott had $16.5 million in operating cash flows. A year ago cash flow figures were poor when the company reported negative operating cash flows of $7.5 million. Cash balance has come down to $470 million in the last six months. However, the main reason for this decline was the prepayment of $75 million term loan. Despite a decrease in the cash balances, the liquidity remains strong. Operating income is getting better despite a decline in revenue, indicating efficient execution of the ongoing projects. McDermott will need to keep this efficiency in order to really take advantage of the order backlog it has amassed. Delays in projects will have a negative impact on the revenues as well as cash flows.
The mood is slowly becoming positive in the oil and gas industry as more analysts are now coming out with predictions for a turnaround in 2017. A new estimate by Bloomberg is showing that the average price of crude oil will be $57 per barrel. They averaged the estimates of 20 analysts. This might be a price level that prompts energy companies to increase capital spending. Most of the industry analysts as well as the agencies like EIA are predicting a balance between supply and demand during the next year. As the prices start to rise upstream companies will start to increase capital spending. McDermott is exposed to some extent because the majority of its revenue comes from two customers: Saudi Aramco and Inpex. However, these two customers are looking to complete their projects quickly and the threat is not significant to McDermott. As the capital spending increases from other companies, McDermott will have an opportunity to diversify its customer base. In a challenging market, McDermott is proving to be a good investment. There is still a lot more to come from this stock.
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