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McDermott International (NYSE:MDR) is a global engineering and construction firm active in offshore oil and gas construction, power generation systems, and government contracting. The offshore business segment includes subsidiary J. Ray McDermott, which builds deepwater and subsea oil and gas facilities. McDermott International's power segment is led by Babcock & Wilcox and builds fossil-fuel, nuclear, and other generation systems. Subsidiary BWX Technologies is the driving force in the company's government segment, which provides nuclear components and services to US government agencies (accounting for about 15% of the parent company's business).

We put this stock in the OLI Spotlight in November of 2005, when it was trading at $36 a share.  That was before the 3 for 2 split in mid-2006.  The stock has gone nowhere but up since.  After the first quarter's report of this year, the stock jumped 75%.  Can it keep going?

It will if earnings keep growing as they have.  Analysts predict earnings will increase by 27% a year, on average, over the next 5 years while revenues increase by 19% a year, on average, in the same time period.  Earnings per share [EPS] were 60 cents in 2004, more than doubled in 2005 to $1.37, then more than doubled again in 2006 to $2.81.  Analysts are looking for $4.36 this year and $4.85 next year.  Revenues are ramping, from $1.92 billion in 2004 to a current run rate of $5.585 billion for this year.

The one number that really pops out in this stock, even better than the earnings growth, is the Return on Equity.  From 2002 until 2004, it was zero.  Then in 2005, it went to 11.4%.  In 2006, it jumped to 82.5%.  This year, analysts expect 51.5% and 42% next year.  You'll have to look long and hard to find a stock with similar or better returns.

Where is all the goodness coming from?  First, the offshore oil & gas construction division (J. Ray) is benefitting from strong activity in the Middle East, Asia/Pacific, and Caspian areas.  Its backlog is over $4 billion and growing.  That means 2008 is pretty much in the bag as far as earnings go.  The power generation systems group (B&W) has seen margins increase in its service and parts business.  There's been an increase in boilers and retrofit projects as well.  Backlog in this division is up over last year.  Finally, the third sector, the government operations group [BWXT] is seeing increased demand for nuclear components from U.S. government programs.  The profit margins for these parts are contributing in a meaningful way to overall profitability.

So all this is good news.  But it just might all be in the stock price already.  Nothing goes up forever.  And when a stock has gone from $1.60 to $94 (split adjusted) in 5 years, investors need to curb their enthusiasm.  The large jump in earnings, where they doubled for 2  years and then slowed only a little, can't go on.  In fact, going from $4.35 (expected this year) to $4.85 (forecast for next year) is only 11.5%.  It's extremely difficult to grow earnings as a company gets larger since the base number is so large to begin with.

Maybe MDR will surprise everyone and show earnings that beat expectations.  They've done it before.  On the other hand, caution would seem warranted at these lofty levels, especially since they were reached so quickly.  Typically stocks that go up this fast have a tendency to have some pull back as investors take profits and move to the next stock.  MDR is a great stock.  The price tells you that.  Can it be an even better stock?  Time will tell.

Disclosure: Author has no position in MDR

Source: McDermott International: To The Moon?