McDermott International's Stellar Expectations

Summary

• The management team at McDermott announced significant cash flow following the completion of its absorption of CBI earlier this year.
• Due to additional product lines and a recovery in the energy space, the infrastructure business sees significant opportunities in the years to come.
• This year is expected to be a wash on a cash flow basis, but the firm has enough cash to survive and can wait for the awards its hoping for.

Owning shares of McDermott International (MDR) over the past few years has been a heck of a rollercoaster, especially when you consider that management, on May 10th of this year, finished its merger with Chicago Bridge & Iron (aka CBI). As the energy space contracted materially starting in 2014, and as key projects from CBI’s acquisition of Shaw ran over, the infrastructure firm and its investors suffered, but the combination with McDermott is finally starting to show some positive results. In McDermott’s latest earnings release, management discussed future steps for the entity and they highlighted significant opportunities that should, if all goes well, generate attractive value for investors for years to come.

Great results

Pretty much no matter how you stack it, McDermott fared well during the quarter. According to management, for instance, operating cash flow came in at $398 million, while free cash flow was a hefty $374 million. These compare to the second quarter results of the business’s 2017 fiscal year of just $42 million and $24 million, respectively. Thanks to robust cash flow in the quarter, operating cash flow in the second half of 2018 totaled $435 million, up from last year’s $91 million. Free cash flow during this period of time was $392 million, up from a paltry $10 million a year earlier.

Another great showing for McDermott related to the company’s final estimates related to CBI’s problem contracts. One major point of uncertainty from shareholders in both McDermott and CBI had been that CBI’s management team was either under-stating project costs intentionally or that it had a poor ability to foresee what costs would end up being. Either way, with McDermott in the driver’s seat, there appears to be optimism that past mistakes won’t carry on into the future.

*Taken from McDermott International

This optimism is demonstrated by the fact that, during the quarter, management said they realized $165 million in changes to its Cameron LNG project, $23 million for its Calpine project, and $33 million toward the now-completed IPL gas power project and shares still managed to rise around 12% in response to the news. This is likely because, though these are sizable figures, management asserts Cameron is 88% completed while Calpine is 89% completed. Add to this management’s belief, in their earnings call, that necessary changes have been made to see that these projects are completed and that these dollar amounts, while disappointing, were in the range management forecasted, and it seems clear that shareholders are, at the least, giving the firm the benefit of the doubt.

*Taken from McDermott International

In addition to these developments, management also informed investors that the integration of McDermott and CBI has been moving along nicely. So far, it’s believed that $163 million worth of run-rate synergies have been realized and this figure is expected to grow, as a result, to $350 million. This is significant for shareholders and management alike because the ability of McDermott to generate synergies was a big piece of the reason why the merger was sought.

*Taken from McDermott International

A wonderful expectation

Not only were results positive for McDermott and CBI during the quarter, the company also announced that the future has the makings of a real turnaround. You see, according to management, the business had not only $10.2 billion worth of backlog, it also has $19 billion worth of projects that management has already issued bids or change orders for. On top of these figures, McDermott has identified a further $49.3 billion worth of target projects that it may be able to win.

*Taken from McDermott International

To put this in perspective, the target projects value is three and a half times the $14.1 billion in targets McDermott had previously forecasted. What this suggests is an amazing amount of revenue growth potential for shareholders to capture in the years to come if management is correct. It’s worth mentioning here that $26.5 billion of these targets are located between North America, Central America, and South America. A vast majority of this work is due to a recovery in energy production within the US, combined with differences in what offerings CBI brought to the table compared to what McDermott did before the merger (mostly the latter). Irrespective of the cause, though, these figures are exciting.

The rest of this year will be a wash

Even though cash flow figures this last quarter were robust, investors shouldn’t anticipate the trend to continue near-term. For the rest of this year, it’s expected that CBI will generate operating cash flow of -$360 million and free cash flow of -$440 million. The timing of payments and cash inflows related to current projects is certainly a contributor to this, but so too will be capital spent to ensure its run-rate synergies target is met. In the latest quarter, McDermott realized $63 million in costs associated with capturing synergies, but that still leaves an estimated $210 million that will ultimately be spent in order for management to hit their target.

*Taken from McDermott International

This suggests pain, especially when McDermott has a negative book value and $3.6 billion worth of gross debt, but the company should be alright so long as projects continue to find their way to its coffers. This is because the infrastructure giant had, at the end of its second quarter, $814 million worth of cash and cash equivalents at its exposure. In addition to that, it has a further $324 million in restricted cash, but that can only be tapped to pay down liabilities that the cash has been restricted in order to protect. As long as 2019 results in actual positive or at least neutral cash flow, McDermott has the financial footing to survive comfortably.

Takeaway

It’s nice gaining some insight from McDermott’s management team post-merger. Whenever companies combine, it creates a tremendous amount of uncertainty for a time, but with this press release the business has provided investors with a clear look into what the rest of this year will look like and has given a hint at the prospects in years to come. It is disappointing, in my view, that the rest of 2018 will see negative cash flow, but McDermott’s financial position is sturdy enough to soldier on and capture the upswing from future projects.

Analyst’s 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.