McDermott International: OPEC Boost

| About: McDermott International, (MDR)

Summary

OPEC agreement will bring certainty to the oil markets.

Stability will bring new investments.

Order backlog gives earnings and cash flow visibility.

Growing margins will further enhance EBITDA.

Full-year and 2017 debt metrics will come down due to the rising EBITDA figures.

Now that the cloud of uncertainty has been removed from the global oil markets, prices can start to move higher. This is good news for McDermott International (NYSE:MDR). The stock was already performing well due to the strong order backlog, wide geographical presence and healthy relations with customers. McDermott's ability to provide services from design to execution has allowed it to perform better than almost all of its peers in the oilfield services sector. Now that the oil market is finally moving towards sustained recovery, investment in new projects should increase. This should make companies like McDermott International very happy.

There are some differentiating factors that give McDermott International an advantage over its peers. Most important of these factors is strong relations with national oil companies. Historically, it has been a challenge for foreign companies to have healthy relationships with national oil companies in the Middle East. Not for McDermott International. In fact, deep relations with these companies has been the key driver behind growing backlog and healthy revenue even in the last two years. Saudi Aramco, the national oil company of Saudi Arabia, accounts for more than 25% of its total revenue. In normal circumstances, such high exposure to one customer will be taken as a negative and a potential threat. However, McDermott's ability to maintain relationship with customers and extract more revenue from the same customer has allowed it to sail without any problem. It is the company's capacity to offer full suite of services that has made it indispensable to its customers in the Middle East. Maintaining such a strong position in one of the most volatile regions in the world is a credit to the management's ability.

This good work has translated into some visible growth. Out of $3.9 billion in total backlog, $2.4 billion will roll off in 2017. This gives reasonable visibility to revenue and cash flow growth in the short term. The company has been able to consistently beat market expectations in the last few quarters. For the third quarter, McDermott again reported better-than-expected results. Adjusted EPS was $0.09 - adjustments were mainly related to restructuring charges. The most important change, however, was the improvement in operating margin. Year over year, operating margin improved by 3.5% while the adjusted operating margin went up by 3%.

Operating cash flows for the nine-month period have gone over $126 million and cash balances are at $500 million. EBITDA figures are also extremely encouraging. Third-quarter EBITDA was $71 million, lower than the second quarter EBITDA of $85 million. However, the overall EBITDA figure for the year is on its way to be over $250 million. This is going to have a positive effect on the debt metrics and total leverage. Improving cash flows give more interest coverage. If we take into account the last 12-month EBITDA, then the debt/EDITDA ratio is at over 3.2x. This ratio is not terribly high, but a multiple below 3x will make it a candidate for an upgrade from the rating agencies. McDermott is targeting full-year 2016 EBITDA of $256 million, which is achievable. In fact, if the trend in the last three quarters continues, then the company will generate EBITDA in excess of its full-year target. Nine-month EBITDA is $213 million. This will bring down the leverage ratio to 2.75x.

More than $2.4 billion is expected to come in revenue in the next year. Improving margins and cost management means that the EBITDA figures will go up in the next 12 months. If we assume an EBITDA figure of $300 million in 2017, then the debt-to-EBITDA ratio will be close to 2.3x. This figure does not assume any reduction in long-term debt over the next 12 months. EBITDA in excess of $300 million will not be an impossible ask for the company. At the moment, the company is in compliance with all of its covenants.

McDermott has sufficient cash reserves and cash flow generation ability to meet its capital spending (around $250 million), working capital and any debt repayment obligations. There are going to be new investments all over the world in the next 12 months as the oil prices go over $60 per barrel. McDermott stands to benefit heavily from this increased investment due to its full suite services and close ties with the customers. There is going to be an increase in the order backlog and cash flows. All these factors make it a very good long-term investment.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.