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Dr. Paul Price
Dr. Paul Price
Articles (513)  | Author's Website |

A Triple Play that Might Score – McDermott International

December 03, 2008 | About:
McDermott International [NYSE:MDR] current price: $8.30. 52-week range: $5.98 (Nov. 20, 2008) - $67.14 (Jun. 9, 2008)

McDermott Intl. has three main businesses. BWX Technologies is the sole supplier of nuclear fuel assemblies to the U.S. Navy. Babcock and Wilcox manufactures environmental equipment, boilers and other parts and services for utility companies, and their J. Ray McDermott division provides marine construction to customers in the offshore oil and gas industries.

2007 through mid-year 2008 proved to be the high water mark for EPS for MDR as oil prices stimulated E & P worldwide. EPS peaked at $2.66 in 2007 with MDR shares hitting an all-time high of $67.14 this past June. With oil prices falling back these shares have tumbled to just over $8 despite current consensus estimates of $2.12 and $1.91 for 2008 and 2009 respectively.

Momentum investors have bailed out leaving these shares are < 4.4x next year’s already reduced estimate. That’s the lowest P/E in over 15 years on these shares. It’s also the lowest absolute dollar price (excepting the past few weeks) since early 2005 when full year EPS came in at $0.66.

McDermott has a strong balance sheet. Total debt was only $13 MM at mid-year 2008 versus cash holdings of over $1 billion. Total interest coverage is > 25x. Book value is approximately $7 /share.

Insiders have been snapping up the shares. Since November 10th five separate insider purchases were reported at prices from $6.45 to $10.29 per share. There were no reported insider sales since July and August and those took place at prices of $47.83 to $60.83.

Patient investors could see a huge run up in price from today’s quote. The peak prices in each calendar year 2005 – 2008 were $15, $26.70, $62.80 and $67.14 respectively. Even eight times next year’s $1.91 estimate would bring these shares back to $15.28 or + 84% from here.

Want a nice 13 ½ month option play?

………………….........................………………………….Cash Outlay……..Cash Inflow

Buy 1000 shares of MDR @ $8.30 …….............….. ($8,300)

Sell 10 MDR Jan. 2010 $10 Calls @ $2.75 ………...............……………. $2,750

Sell 10 MDR Jan. 2010 $10 Puts @ $4.10 ……..............……………….. $4,100

Net Cash Out-of-Pocket ……………................……… (1,450)

If MDR shares are > $10 on expiration date in January 2010

(a gain of 20.5% from your starting point):

Your $10 calls will be exercised and the shares sold for $10,000.

Your $10 puts will expire worthless (a good thing for you- the seller).

You will be left with no shares, no option obligations and $10,000 cash for your original $1,450 cash outlay. A very nice gain.

Worst case, (if MDR is under $10 on expiration date), you would end up owning 2000 shares of MDR.

The original shares and the exercised $10 puts.

What’s your breakeven on the whole trade?

On the shares you bought at $8.30- it’s that price less the $2.75 call premium or $5.55 /share.

On the “put” shares- it’s the $10 strike price less the $4.10 put premium = $5.90 /share.

Your 2000 shares would have an average cost of $5.73 or 31% below the $8.30 starting price.

Disclosure: Author owns shares and is short puts on MDR.

About the author:

Dr. Paul Price


Visit Dr. Paul Price's Website

Rating: 3.1/5 (16 votes)


Dr. Paul Price
Dr. Paul Price - 9 years ago    Report SPAM
GuruFocus has noted that PRIMECAP Management recently added to its MDR position.

[MDR] McDermott... PRIMECAP Management

11-30-2008 Added 18.03% @ $9.75 /share

Dr. Paul Price
Dr. Paul Price - 8 years ago    Report SPAM
MDR shares are now at $16.65 making this trade look very likley to achieve its best case scenario.
Dr. Paul Price
Dr. Paul Price - 8 years ago    Report SPAM
As noted in the original post:

Should MDR shares still be above $10 on January 15th, 2010 you will have $10,000 cash for each $1,450 actual cash you put into this trade.

That's a 589% cash-on-cash return.
Dr. Paul Price
Dr. Paul Price - 8 years ago    Report SPAM


An Energy Play With a Safety Net


McDermott International, a leading engineering-and-construction firm, is a different kind of oil and gas stock.

IT LOOKS LIKE THE energy sector has entered a new phase, thanks to rising oil and gas prices.

Still, for those investors reluctant to bet directly on movement in commodity prices, there are energy stocks that are more defensive in nature.

Take McDermott International (ticker: MDR), a leading engineering-and-construction company focused on the energy sector.

McDermott plays a supporting role in the business of drilling for fossil fuels. After an offshore well has been drilled, the company installs drilling platforms and builds pipelines needed to extract and transport oil and natural gas. It also provides utilities with "after-market" maintenance and parts, and is a leader in retrofitting coal-fired plants with cleaner technology.

At a Glance:

McDermott International (MDR)

Stock Price: $17.60

52-Wk High: $67.14

52-Wk Low: $5.98

Market Cap: $4.02 billion

Est. 2009 EPS: $1.49

2009 P/E: 11.8x

Est. Long-Term EPS Growth: * 11%

Est. ('09/'08) EPS Growth: -20%

Revenue (trailing 12 months): $6.6 billion

Dividend Yield: None

Chief Executive Officer: John A. Fees

Headquarters: Houston, Texas

*Based on analyst estimates looking ahead three to five years.

Sources: Thomson Reuters, Barrons.com

The company also manages the U.S. government's nuclear labs and clean-up sites, backed by federal stimulus funding.

While growth has slowed, McDermott is sustaining a backlog near record levels, thanks to steady demand from its customers, including major integrated and national oil companies, large U.S. utilities and Uncle Sam.

McDermott "is one of my top picks; you have a very well-positioned diversified infrastructure play, and [its] financial health is very strong," says Lazard Capital Markets analyst Graham Mattison.

But the thorn in McDermott's side has been a Middle East pipeline project the company is involved in. High inflation in Qatar and unfavorable weather conditions that delayed construction have caused costs to run up and have compressed margins for this fixed-price contract.

McDermott has "been punished by investors and it is trying to rebuild its credibility," says Broadpoint AmTech analyst Will Gabrielski. As the company addresses the pipeline problem, he says the stock looks "very attractive and it will be an outperformer over the next year or two."

The stock has rebounded from a low of $5.68 in November 2008 to close at $17.60 Wednesday after taking a hefty charge in the fourth quarter and issuing a favorable progress report for the Qatar pipeline in March. But shares are still down 68% over the past 12 months.

Trading at 11.8 times 2009 and 9.4 times 2010 earnings estimates, the valuation looks attractive for investors seeking to play an aggressive build-out in energy infrastructure.

The International Energy Agency estimates that more than $26 trillion will be needed to be invested in energy infrastructure through 2030 to meet rising global demand.

Roughly half of the company's revenues come from its oil-and-gas unit, 40% from the power-generation division and the rest from government contracts, the fastest-growing segment. International projects made up more than half of revenues.

Unlike other engineering-and-construction companies, McDermott is well entrenched in major offshore energy projects and is one of the few global contractors that can provide services from the design phase through construction.

McDermott is involved in long-term projects where well-funded customers are racing to replace depleting reserves. Plus the offshore work is tied to wells that have been drilled years ago and is already accounted for in spending budgets.

Earnings and backlog growth is expected to be flat or slightly positive this year, but a recovery in margins will be the lead story for this unit. The Qatar pipeline project, with break-even operating margins, caused the oil-and-gas unit's margins to fall from 10%-12% earlier in 2008 to 1.8% by the end of the year. An uptick to 2% and improved execution could help the stock recover when the company reports first-quarter results on May 11, says UBS analyst Steven Fisher.

Readers can get intraday updates on the performance of Barron's and Barrons.com's stocks picks and pans on this Website www.barrons.com/stockpicks

Overall, contract-award activity is showing signs of improvement, and will likely pick up later this year or in early 2010 amid stabilizing commodity prices and optimism about the economy, says Andy Kaplowitz, director of equity research at Barclays Capital.

McDermott won an offshore Saudi gas project, estimated at $1.2 billion, in the first quarter. It could boost the contract backlog to $10 billion, from $9.8 billion at the end of 2008, and go a long way in reassuring investors, Kaplowitz says.

As a leader in providing carbon-capturing and nuclear technology, McDermott is also a longer-term play on carbon legislation and the anticipated increase in new power plants, once Washington sets the rules. McDermott is also pursuing more international projects.

Meanwhile, half of the power-generation unit's revenues come from providing utilities with maintenance parts and services.

This steady revenue stream, plus regular fees earned from government contracts, creates a "valuation floor" for the stock in the low teens, Kaplowitz says.

There's some comfort in that.

Dr. Paul Price
Dr. Paul Price - 8 years ago    Report SPAM
Constructive on McDermott International

Credit Suisse says the engineering firm can grow EPS in 2010.

McDermott International (NYSE: MDR)

Credit Suisse ($24.75, Sept. 8, 2009)

WE UPGRADE McDermott International to Outperform from Neutral (ticker: MDR) as we believe McDermott will be one of the few engineering and construction companies that can grow earnings per share in 2010, as the market shifts towards upstream and as problem projects are completed.

We increase our 2010 and 2011 EPS to $2.05 and $2.40, respectively. The raise reflects our increased confidence on J. Ray awards and margin improvement, partially offset by lower revenue and profit dollars in power generation.

Over half of McDermott's revenues are generated from the upstream market, the sweet spot of the oil and gas market over the next several years. Bidding activity in the Middle East and Asia Pacific remains very high, with sizable awards coming at the end of 2009 and beyond. Requests for Proposals (RFPs) in the Caspian region are also tracking ahead of schedule by one year.

The last of three problem projects will be done in fourth-quarter 2009. Even so, margins have improved each quarter, from losses last year to now over an 8% margin, suggesting management has control of the issues. Excluding problem projects, margins are tracking at the high end of the 10%-12% range. Last, McDermott expects oil and gas profits in 2011-2013 to be higher than 2005-2007 (peak margins of 16.5% were in 2007).

Albeit a longer-term opportunity (2013 and beyond), McDermott is developing a modular nuclear reactor which is comparable on cost per MW, reduces the cost risk for the utility, is scalable, easier to finance and cuts time to build a nuclear power plant by almost half. This could be a sizable and very profitable opportunity for McDermott International.

Our new $31 price target (25% upside) [up from $27] assumes 14 times (above 13 times used previously, reflecting resolution of problem projects and higher growth prospects than peers) our 2011 EPS, discounted back.

-- Jamie Cook

-- Chase Becker

-- Peter Chang

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