Heavy Construction: 1 Stock to Miss, 2 to Buy

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

Both Chinese and US economies are showing signs of recovery, and their respective stimulus packages are expected to further bolster their infrastructure growth. This presents a good growth potential for heavy construction companies, and here are a few picks that can make it to your portfolio.

Reasons to be Bullish On McDermott International

Shares of McDermott International (NYSE: MDR) may not have risen significantly YTD, but that’s not a barometer for its past financial performance. On a quarterly basis, the company reported an EPS of $0.21 against $0.04 in last year’s quarter. Its revenues stood at $1.03 billion, which were up by 16.9%, beating the street’s estimates by 4.6%. The company ended the recent quarter with $720 million in cash and cash equivalents, with liabilities of only $108 million. Also its order backlog of $5.3 billion is at record levels, and management expects a double digit growth rate for its revenues in 2013. Overall the balance sheet looks solid.

McDermott enjoys a gross profit margin of 14.1% which is higher than the industry average. Its shares appear to be undervalued with a forward P/E of 12.48x and a PEG of 0.54x. Additionally its P/S of 0.74x and debt/equity ratio of 0.06x are quite impressive. Analysts expects McDermott's annual EPS growth rate to average around 27.9% for the next 5 years, which means that its shares could quadruple in value in around 5 years.

Reasons to be Bullish On Fluor Corporation

Fluor Corporation (NYSE: FLR) has an even bigger cash pile, with $2.8 billion under “consolidated cash and marketable securities.” Couple it with a meager debt/equity of 15%, and its balance sheet looks solid. To bolster EPS growth, the company repurchased 600,000 of its shares, and paid out $27 million in quarterly dividends. The management also raised its 2013 EPS forecast from $3.50-$3.80 to $3.85-$4.35, and its investors have had a pleasant ride YTD.

The company has backlog orders worth $41 billion, which exceeds its market cap by a whopping 330%. According to my calculations, this backlog singlehandedly accounts to $1.11 billion in potential net earnings or an EPS of $6.72. Analysts expect its annual EPS growth rate to average around 11.85% which means the stock could double in value in about 6 years. Its shares trade at a forward P/E of 13.72x which indicates that its shares are still undervalued.

Why Foster Wheeler Should Be Avoided

However another heavy construction company, Foster Wheeler (NASDAQ: FWLT) seems to be struggling with its backlog. The management expects its overall backlog to decline in Q4 on a sequential basis, but believes that FY12 backlog would be higher than FY11. Its “scope new orders in Global E&C Group” is at record levels, with 31% increase on a sequential basis. Surprisingly, during the earnings call, its overall order backlog was never revealed, and management said that the overall backlog was “strong,” compared to its 2009 levels. It’s a well-known fact that 2009-2010 was a bad year for almost all companies, and comparing the current financials to troubled times is not fair.

Yes the company has reported stellar financial results, and the company appears to be undervalued. However its massive P/FCF of 48.37x is discouraging. Additionally 13 of its top executives have been unloading their shares since August, and it’s a well-known fact that large scale insider transactions indicate the company’s future performance. I strongly believe that despite the term “solid backlog growth,” investors should stay cautious.

A Short Conclusion

Both McDermott International and Fluor Corporation have reported stellar financials, and enjoy high margins. With strong cash reserves and no debt problems, both the companies seem well poised to grow. Their fattening is another positive. Their shares appear to be undervalued, and both Fluor Corporation and McDermott International get a Foolish Buy Rating. However I believe that investors should avoid Foster Wheeler, due to the absence of positive triggers, and a non-specific guidance by the management.

 
 


PiyushArora has no positions in the stocks mentioned above. 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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