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McDermott Value Trap Or Turn Around/

|About: McDermott International, Inc. (MDR)
Summary

Merger with CB&I brought opportunity and pain.

Future unsure, but interesting to follow.

Potential for upside.

My Investment thesis of McDermott International:

Summary: Primary Reason: A Significant series of “Events:

  • Before McDermott merged with CB&I - CB&I did not properly bid to account for mega-project EPC challenges in the Gulf Coast like labor productivity and labor availability along with other issues not fully Id’s with materials - and McDermott due diligence was less than stellar in evaluating these existing LNG projects - Cameron, and Freeport.
  • 4th Q 2018 guidance did not accurately lay out the challenges and 1st Q guidance for 2019 year-end were optimistic.
  • Stock price has dropped from About $20 per share to $4.60 per share.
  • Future stock price in 2021 could be in range of $15-$20 per share a fair value for this company.
  • And additionally, there is a current disagreement with the Pemex for roughly $33mm.
  • Overcoming Events:
    1. The “legacy” projects have been reevaluated internally and with the customers and renegotiated with appropriate schedules and commitments. All parties are committed to completing these project around mid-2020 successfully.
    2. While, there are still risks for material cost overruns, labor overruns, and potential weather impacts in the region which could delay or cause further losses on these projects, these types of issues are being negotiated with full understanding of these challenges and risk evaluations.
    3. McDermott has won $19 billion of new awards - which shows their customers’ believe they can perform the work and have the leadership to execute the projects.
    4. Management is projecting that only 14% on 2020 revenue will be these “zero” margin legacy projects.
  1. Time Frame for my Investment and Expected of Return:
    1. My evaluation shows the potential for $1.00 per share net income for 2020.
    2. With a positive $1.00 per share net income and improved performance and contract terms on future work, It is likely that the fair value for the company could be 10x’s Earnings or $10.00 per share. As the backlog progresses into 2021 and net income moves potentially closer to $2.00 per share, it is possible to see a fair value of $20.00 per share.
  2. Big sales numbers:
    1. Since May 2018 when CB&I and McDermott merged their sales have reached an all-time high yielding a backlog of $19b as of the end of the 2nd quarter. And in July it increased again to $21b. Since each of the “Mega” are 10% of their backlog each win adds substantial profitability potential and risks.

What can go Wrong:

  1. “legacy” projects experience more challenges and therefore unrecovered costs (losses).
  2. New projects’ schedules slip due to economic conditions.
  3. Performance on new projects (labor productivity, material availability, schedule challenges, weather delays, etc.) do not meet contract terms for incentives and/or lose money.
  4. To recover costs on Pemex there are significant “lost time” for management that is not spent concerned about new projects.
  5. The overall market does not recognize the company’s performance improvement due to overall market downward movement.

6. Major portions of the work is provided by their JV partners Zachry and Chiodya and they may not perform.

7. When the companies merged with was about 1 1/2 years ago that is not much time for the management team to full integrate the staffs and leading mangers of McDermott land CB&I.

Further, CB&I management may have bid the “legacy” projects aggressively to save their company and make them attractive to suitors. We cannot know from the outside whether they have become together as a competent large contractor so soon. Only time will tell.

Rebuttal:

  1. Renegotiated terms and schedules with integrated management oversight have “confidence” that these projects will not get out of hand.
  2. For now the Petro chemical onshore and off shore LNG projects have customers under contract for the sale of the delivered products from the processing plants. Other areas could slip due to demand, cash flow, politics, or other reasons, but the large LNG projects have high probability of reaching completion.
  3. New projects are being bid and negotiated with full, rigorous risk management evaluations and associated contract terms tat account for big adjustments due to labor, materials, cost and schedule.
  4. Pemex challenges in the past have been able to be resolved simply with due diligence and time. However, the regime changes in PEMEX make settlement success and timing unknowable. So the losses have been taken this quarter. So any future settlements would result in positive influence on the bottom line,
  5. There is “no way”to accurately predict the direction of the market. However, the 4th year of Presidential terms are usually more volatile. Making this risk more challenging to assess. However, improving net margins, profitability in down markets can be delayed but are generally recognized.
  6. Major portions of these projects are now built in “construction” years away from remote construction sites until the modules are shipped an installed.
  7. Their JV partner(s) have worked on several LNG units to date and have learned how to work to gather and strengths and weaknesses

How confident do I feel toward investing(up to 10% of my assets in this company at it's current price of $4.60.

I am about 70% confident that the company can meet it's 2020 objectives.

I am about 80% confident that at the end of 2020 if they have continued to project $1.00 + for net income the price could be increased to $10 per share.

I am 100% confident that the management team is trying to do everything in their power to improve their performance and that incentives are in the right places, for recognition when they do.

I am 80% that they have all right management in place to successfully complete their dramatic increase in project backlog.

Conclusion:

  1. McDermott is a very sophisticated EPC onshore and off shore contractor with the ability to serve clients all over the world. The merger with CB&I has strengthened their portfolio of potential projects and capabilities.
  2. McDermott’s potential fair value is highly dependent on their performance on very large, complex and challenging projects - assuming they will be successful the potential 2020+ fair value could be $10.00+. This would provide a potential for substantial return in 18 to 24 months from now.
  3. Caution: The engineering/construction industry is cyclical, thus performance for McDermott cannot be determined for more than a couple of years at a time and it is highly dependent on large client commitments for expansions, “new field” projects which can be delayed or canceled if markets for products change.
  4. I have purposely been conservative in my evaluation, because, to date, the management team has not demonstrated the ability to accurately predict their fortune as McDermott (CB&I).

Disclosure: I am long on this stock.,

Note:

This is not to be considered investment advice nor is this a recommendation for buying the company stock. I am not a financial advisor. I am currently long with this investment.

Disclosure: I am/we are long MDR.