On Mar 4, Zacks Investment Research downgraded energy-focused engineering and construction firm McDermott International Inc. MDR to a Zacks Rank #5 (Strong Sell).
Why the Downgrade?
Despite McDermott’s return to profitability in the just-released fourth quarter, lack of visibility on the company’s earnings and revenue growth, plus the weak award environment are big near-term concerns.
Detailed Analysis
McDermott derives its revenues from companies in the oil and gas exploration and production (E&P) industry, a highly volatile and cyclical sector that is directly exposed to commodity prices. As a result, the ongoing slump in oil and gas prices have curtailed deepwater drilling and dampened subsea equipment demand, adversely affecting bookings at McDermott.
As it is, McDermott’s operating numbers over the past few quarters have been highly unpredictable, as it had to deal with steep operating costs, competitive pressure and project implementation issues.
Also, McDermott has historically used bolt-on acquisitions to plug holes in its product/service portfolio. The company may find it difficult to complete accretive transactions in the future, which could negatively impact its growth rate.
Finally, McDermott sells about 60% of its products and services under fixed-price contracts, many of which contain price escalation clauses based on the consumer price index. This exposes the company to greater-than-average margin compression.
Stocks That Warrant a Look
While we expect McDermott to perform below its peers and industry levels in the coming months and see little reason for investors to own the stock, one can look at VTTI Energy Partners L.P. VTTI, Western Gas Equity Partners L.P. WGP and Valero Energy Partners L.P. VLP are worth consideration. All these stocks sport a Zacks Rank #1 (Strong Buy).
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