McDermott International vs. Foster Wheeler: All About Margins

I think it is time for the market to declare McDermott International (MDR) best of breed in the infrastructure space now that Foster Wheeler (FWLT) disappointed investors. When I wrote about the infrastructure space last month (MDR Simply the Best in Infrastructure), I pointed out that it was by far the cheapest of the other four show cased stocks - FLR, JEC, FWLT, and SGR. It still is cheapest with a PE of 20, amazing revenue (up 46% over first 9 months of the year) and earnings (123% over the first 9 months of the year), and ROA (15%).

Now FWLT and MDR have reported back to back and the results look decisive. FWLT earned 56 cents, well under the 75 cents expected and blamed it on Italian tariffs, arguments with a customer, and - well, everything but the weather. MDR, on the other hand, beat the street forecast of 64 cents making 70 cents in the quarter. They clobbered the revenue forecast of 1.476 billion getting 1.562 billion.

The big story was the operating margins of the two companies. This quarter MDR achieved 12.3% and for the year as a whole they got 12.7%. FWLT came in this quarter with a sinking 7.6% figure. For the whole year, their operating margin was 10.4%. Now I know the companies in the sector cannot give steady consistent numbers because it is a "lumpy" business. However, all year MDR has outperformed FWLT in operating margins, particularly this last quarter. The analysts in the conference call for FWLT were perplexed about why operating margins were so grim and repeatedly asked for explanation. I don't think they'll ask that question at tomorrow's MDR conference.

Now for some speculation. Wild. Not a lot of proof. But hear me out. I think there is a hidden reason for the weak operating margins that afflict FWLT, as well as others in the space such as FLR, JEC, and SGR. I think these companies underbid projects. They take on huge backlogs of business that are destined to produce lower quality earnings. The Street gets excited about FWLT's astounding backlog not realizing that comes at a price. FWLT's backlog doesn't translate into the kind of earnings MDR can generate. MDR does develop significant backlogs of business but it seems to choose more wisely and thus gets the better operating margins. MDR is the best of breed play in the infrastructure space.

Disclosure: Long MDR

Comments

[TraderMark:]

Stephen, interesting comment about the underbidding; certainly possible, but I dont think MDR and FWLT particulary bid against each other if you are doing apples to apples. FWLT and FLR perhaps... but it could also be a long term strategy - many of the foreign bids are relationship building with people with deep pockets and with what should remain deep pockets for many years. So once you get in there once it might help long term relationships. Ask KBR about that ;)
But food for thought!

2008 Feb 28 03:14 PM

[Stephen Ros...:]

Mark, look at the operating margins of MDR and compare them to FWLT, FLR, SGR, JEC. They are quite a bit higher. At the same time, while MDR has a robust backlog of business, its is a smaller percentage of the total market cap of the company compared to the above 4. I'm not saying they are losing business to the other players in a one to one price war. Rather they are accepting business that is more profitable. I suspect the others are taking less profitable jobs and in effect under bidding. The market gets overexcited about large back logs. I get excited when they can turn the jobs they have into big profits. The operating margins are the key. FLR for instance had 4.8% margins this last quarter (rising over their previous rather sad 3%), a $1.35 a share tax benefit, PE 36, not as good as MDR. Take away the 123 million dollar tax benefit and FLR is left with 136 million dollar profit. MDR and FLR have identical market caps. MDR made 186 million. Again better run, better margins.

2008 Feb 28 08:54 PM

[Jake2:]

Nice job and a good place for me to look a little deeper. Thank you.

2008 Feb 29 02:12 PM

[todaysits:]

Great info. I agree that MDR has been beating FWLT to this point, but FWLT has an earnings growth rate of 25% over the next 2 years, while MDR expects to grow only 8%. All things being equal at this point, I would rather give my money a chance at 25%.

2008 Feb 29 11:38 PM

[Stephen Ros...:]

To todaysits: Actually FWLT and MDR have the same long term growth forecasts from analyst consensus. My forecast is that MDR will outperform FWLT.

2008 Mar 01 07:00 PM