While upstream and integrated oil companies are the most direct play, in truth these firms rarely show up in MFI. Oil drilling (and refining) are heavily capital-intensive activities, making returns on invested capital for these firms relatively unattractive to the strategy.
In fact, reviewing the present screens, I see no highly ranked "pure" oil companies at all.
However, there are some auxiliary plays. One I want to discuss here is Fluor (FLR).
Building The Infrastructure Of Oil (Among Others)
Fluor is an engineering & construction ("E&C") company. Basically, firms contract with Fluor to build those capital intensive drilling, transportation, and refining facilities. Oil & Gas customers are Fluor's largest end market - close to 60% of this year's revenues, 53% of profits, 74% of recent new awards, and 66% of total backlog.
But Fluor is not a pure play - it is one of a few diversified E&C firms. The company also has a sizable Industrial & Infrastructure business that services mining, transportation, healthcare, and other end industries. I&I is currently about 12% of backlog, but is declining rapidly as mining customers cut back on new projects due to extended declines in copper, silver, gold, and coal prices.
Other end markets include handling the LOGCAP IV logistics and supply contract for the U.S. military (20% of backlog), as well as power plant design, construction, and maintenance (2%).
3 Reasons To Like Fluor
There are 3 reasons I like Fluor at its current valuation.
First is scale and diversity. E&C is a highly competitive industry, but Fluor is the largest publicly traded E&C and one of the largest in the world (privately-owned Bechtel might be slightly larger). Few competitors can match Fluor's ability to handle large, complex projects at a worldwide scope, narrowing its effective competition for many jobs. Additionally, Fluor's exposure to numerous industries outside of Oil & Gas has helped it maintain very steady revenue and cash flows. Even during the 2008-09 "Great Recession", Fluor's revenues and cash flows remained steady.
Second is Fluor's financial strength. The company maintains a very strong balance sheet, with $2.4 billion in cash and investments dwarfing its $526 million in total debt. Less than $30 million of that debt is due within a year. Fluor has been a strong free cash flow (FCF) generator. Its 1.4% dividend is easily covered at under 30% of FCF. This allows the company to be aggressive in buying back shares of its relatively volatile stock when the opportunity arises. With the stock currently down 26% from its 52-week high, the recent 10 million share expansion (6% of the float) in the company's buyback program makes a lot of sense.
Finally, and most importantly, Fluor's valuation is at a near 5-year low, despite the company continuing to grow its new awards and backlog. The company's current earnings yield is 13.5%, a level not seen since 2010 - its 5-year average is is about 10.8%. A return to average would put the stock near $75. It is not like the company is struggling to gain business - new orders increased 17% in the most recent quarter, and backlog was up 16%, both very strong figures. The current valuation seems less based on the facts than the fears. Which leads us to the next section...
Why The Market Is Fearful
At the beginning of the article, we mentioned crude oil's price nosedive this fall - a 30% drop in 3 months, from near $95 to today near $66. Put simply, the market is worried about Fluor's critical Oil & Gas business seeing new construction slowdowns as drillers and refiners pull back on spending.
This is not an unimportant risk. Oil & Gas accounts for nearly 2/3 of Fluor's recent order book. The company is already experiencing dramatic, 50% year-over-year reductions to its mining business as prices remain low there. Additionally, the company's LOGCAP government business has likely peaked and the power business, though small, has also seen its backlog drop over 55% this past year. Put simply, Fluor is more levered to oil and gas than it has been in many years - low oil prices are a real threat to future order volumes.
Potential Outweighs Fears
While low oil prices may be a short-term hit to orders, I don't see it as a major long-term threat to the company. Oil prices may very well rebound as rapidly as they fell, spurred by a trading reversal, OPEC production cuts, a cold winter... any number of things. In any case, ongoing development of the U.S.'s emerging fracking empire will require a lot of new (or improved) infrastructure. I don't see oil-based E&C demand crashing by any stretch.
Also, keep in mind that a lot of Fluor's energy work is for natural gas based projects. The company is in charge of several liquified natural gas (LNG) terminal projects, nat gas pipelines in South America and Australia, gas processing plants in Canada, and so forth.
In the big picture, I see probably the #1 player in engineering and construction, a company with a long and proven track record, massive scale and expertise, diversified lines of business, and a very strong balance sheet selling at a 5-year low valuation. Fluor looks like a solid buy at current prices. MagicDiligence believes it is worth at least $75/share, over 25% above current trading prices. We will continue to monitor the stock as a potential Top Buy selection going forward.
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Steve does not own FLR.
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