The Best Risk/Reward in Engineering

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

With the improving economy, both in the United States and in most of the emerging markets worldwide, engineering firms should be very well positioned to profit. With an expected increase in infrastructure spending as well as residential and commercial construction, there should be no shortage of money to be made in the coming years. There are many good choices in the sector, with my personal favorite being Foster Wheeler (NASDAQ: FWLT). Let’s take a deeper look at this company, and compare it with some of the alternatives.

A little bit about the company and what they do

Foster Wheeler is an engineering, construction, and project management company with operations all over the world. In fact, of the company’s $2.2 billion backlog, only about 6% of the contracts are based in North America. 31% is from the Middle East and 25% each from Asia and South America, with the rest from Europe and other areas. So, it is fair to say that Foster Wheeler’s revenue is very dependent on emerging markets, and not so much on the developed world. 

The company operates in two main business groups: Global Engineering and Construction (E&C) and Global Power. The E&C group produces 62% of the total revenue and provides a variety of services targeted at oil and gas processing facilities, refineries, power generation facilities, and more. Global Power makes up the rest of Foster Wheeler’s revenue and produces and builds steam generating and other equipment for power generation facilities. 

One of my favorite things about Foster Wheeler as an investment is that it provides a diverse revenue stream that is made up of several industries that I want exposure to (utilities, oil and gas, chemicals, etc.). 

Growth and valuation

Looking forward, there are plenty of reasons to be bullish on the company. As mentioned, there is a sizable backlog of business that should keep the company busy for a while. Foster Wheeler has also expressed its interest in expanding its business, both geographically and in new sectors such as metals and mining. The biggest geographical expansion potential for the company exists in the areas where the company already focuses its efforts on: the emerging markets in Asia, the Middle East, and South America.

One of the most compelling reasons to own Foster Wheeler is a simple matter of it being cheap. Shares currently trade for 15 times this year’s expected earnings of $1.39 per share. The company’s excellent cash position should also be factored into this, which consists of about $460 million in net cash (cash minus debt); impressive considering that the company’s total market cap is just $2.1 billion. Discounting the cash, the company’s actual current-year P/E is about 11.2.

With earnings projected to grow to $1.97 and $2.39 in 2014 and 2015, respectively, or by 72% in the next two years, the valuation seems amazingly cheap. In other words, excluding cash, Foster Wheeler trades for just 6.9 times 2015’s expected earnings.                                                                                                                                                                                            

A few others to consider: Fluor and Jacobs Engineering

Fluor (NYSE: FLR) is a much larger engineering firm, about five times the size of Foster Wheeler in terms of market cap. The company is slightly less dependent on international revenue; with about 70% of its backlog outside of the U.S. Fluor also has a similar cash position, with about $1.7 billion in net cash. As far as valuation goes, Fluor trades at a slightly higher P/E of 15.8 times this year’s expected earnings, which are expected to grow by 12.1% and 14.3% in the next two years.

While this doesn’t seem quite as exciting as the earnings growth analysts are projecting for Foster Wheeler, it is worth considering that the size and added diversity of Fluor’s business adds some stability, which should definitely be taken into account.

Jacobs Engineering (NYSE: JEC) is similarly sized to Fluor and provides a tremendously diverse array of engineering services to both industrial and government clients all over the world. About a quarter of the company’s business comes from the U.S. government, so Jacobs is quite sensitive to spending cuts, which creates uncertainty in the current political environment.

Jacobs has a very nice balance sheet, but relative to its size, its cash position of about $500 million lags the other two. The company is also significantly more expensive at 18.2 times 2013’s expected earnings, which are expected to grow at about 14% annually for the next few years. This is certainly good growth, but Fluor looks like the better deal out of the two larger firms.

Final thoughts

While Foster Wheeler is the riskiest of the group, due to its less diverse revenue stream and disproportional dependence on the oil and gas industry, I believe that its valuation relative to the reward potential more than makes up for it. For those with less risk tolerance, Fluor would make a solid alternative.

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Matthew Frankel has no position in any stocks mentioned. The Motley Fool owns shares of Fluor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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