KBR: More than Military Contracts

The fund has a relatively small position in KBR (KBR), at only 0.7% of the fund's holdings. KBR is a global infrastructure company which has been spun off of Halliburton. Part of my hesitation has been an over-reliance on military spending and the potential investor 'fears' if there is indeed a draw down in military spending in 2009-2010, especially if a Democratic candidate is elected.

That said, it seems the Democrats are coming to grips with the fact that we will have a significant presence in Iraq for a long long time, although it may be down from current levels. Just this weekend, all 3 major front runners in the Democratic party said they cannot guarantee we will be out of Iraq by the end of their first term (2013!). Another fly in the ointment is many of KBR's contracts were no-bid contracts which will fall under investigation by committee after committee in the next few years.

With all that said, the earnings growth rate and international exposure of KBR is very impressive. Here is a new article via AP about the future diversity of KBR's business.

• LEAGUE CITY, Texas (AP) -- KBR Inc., the former Halliburton subsidiary whose work for the U.S. military in Iraq has prompted congressional inquiries, plans to place greater emphasis on domestic industrial construction and other parts of its business, the company's top executive said Thursday.
• The Houston-based company also hasn't ruled out potential acquisitions to expand its base, Chairman and Chief Executive Bill Utt said.
• Utt acknowledged the military contractor and engineering/construction outfit was likely to continue to do less work in Iraq as troop levels decrease. KBR provides food, laundry and other support services for U.S. personnel.
• As such, KBR will focus on getting back to its roots, Utt said, looking to land more industrial construction and other projects that contributed heavily to its bottom line 20 years ago. Such work accounted for several hundred million dollars a year in revenue in the early 1990s, he said, but had shrunk to less than $100 million a year ago.
• "We see an opportunity with all the capital investment that's going on in the U.S., particularly in this Gulf Coast region, for us to re-establish our position as a constructor,"
• The Army said last month it will examine as many as 18,000 contracts awarded over the past four years to support U.S. forces in Iraq, including awards to KBR, to determine how many are tainted by waste, fraud and abuse.
• The company reported last month its second-quarter earnings rose 52 percent versus a year ago, helped in part by the sale of its stake in a British shipyard. Utt has said that sale is part of an initiative to focus on energy, chemicals and KBR's government and infrastructure arm -- considered to be the drivers of future earnings growth.
• KBR has announced several new contracts in recent months, both in the U.S. and overseas, where it currently does 75 percent to 80 percent of its business.
• Last month, Saudi Arabian oil giant Aramco and Dow Chemical Co. awarded KBR a contract to manage construction of a chemicals and plastics production complex in Ras Tanura, Saudi Arabia -- a plant that's expected to be among the world's largest petrochemical facilities. The companies didn't say how much KBR's contract was worth, but analysts have estimated the cost of the project is $20 billion and KBR's management portion could be worth several hundred million dollars.
• That news came a few days after KBR said it received a $2.8 billion contract for construction of an Algerian liquid natural gas project.
• On the military side, KBR in June was one of three companies awarded respective $5 billion contracts from the Army to provide food and shelter to U.S. troops in Iraq, Afghanistan and Kuwait.
• Another contract, announced in May, to provide program and construction management services for the new Panama City-Bay County International Airport in Florida is indicative of the type of domestic work Utt said he hopes to increase.
• "Where we can find opportunities to jump-start our growth a little bit better through an acquisition, we're going to be interested," he said

Takeaway: So here we have the prototypical company to take advantage of all the global growth, with a 'special' relationship with the US government based on it's tight ties to Halliburton. It appears as some of the US government work draws down, the company will be able to offset this with other growth in new contracts, and its ties in the Middle East provide an entry to take advantage of the petrodollars flowing through the region. Like Cummins (CMI), here is a stock that while based in the US, is essentially a play on foreign growth markets.

KBR is not a cheap stock trading at 34x 2007 estimates and 26x 2008 estimates, which compare about equally with Fluor's estimates, and is more expensive than Foster Wheeler or McDermott. However, its near term earnings growth rates are far and away the best of this group (although revenue growth in the next year leaves something to be desired).

Technically the company has had a huge run, up from $29 to $40 in the last month (+38%). I'd like to add more on KBR but would prefer to see a pullback to mid 30s range, or a 12-13% drop from here. This is the approximate location of its 50 day moving average at this time.