January 12, 2015 McDermott International Inc. Current Recommendation NEUTRAL Prior Recommendation Underperform Date of Last Change 03/04/2013 Current Price (01/09/15) $2.85 Target Price $3.00 SUMMARY DATA SUMMARY (MDR-NYSE) We are maintaining our Neutral recommendation on McDermott International. Given its geographic footprint in high-growth regions, technology leadership and efficient execution skills, MDR is poised to benefit from strong industry fundamentals for offshore construction activities through 2015 and beyond. We believe order flow and backlog for its products and services will continue to be healthy and trend higher in the near-to-medium term. Additional positives include growing international operations and a solid balance sheet. However, several factors will continue to weigh on results, including steep operating costs, an erratic earnings trend over the last few quarters and uncertainty regarding the timing of big awards. As such, we expect its growth potential to be restrained. 52-Week High $9.18 52-Week Low $2.25 One-Year Return (%) -68.37 Beta 1.67 Average Daily Volume (sh) 6,433,288 Shares Outstanding (mil) 238 Market Capitalization ($mil) $677 Short Interest Ratio (days) 8.62 Institutional Ownership (%) 95 Insider Ownership (%) 1 Annual Cash Dividend $0.00 Dividend Yield (%) 0.00 5-Yr. Historical Growth Rates Sales (%) -15.8 Earnings Per Share (%) -26.9 Dividend (%) N/A using TTM EPS N/A using 2015 Estimate 71.3 using 2016 Estimate 8.9 Zacks Rank *: Short Term 1 3 months outlook 3 Hold * Definition / Disclosure on last page Risk Level * High, Type of Stock Small-Value Industry Oil Fld Mch & Eqp Zacks Industry Rank * 249 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 807 A 647 A 687 A 517 A 2,658 A 2014 604 A 476 A 415 A 767 E 2,262 E 2015 706 E 677 E 682 E 765 E 2,830 E 2016 2,927 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.09 A -$0.56 A -$0.27 A -$1.37 A -$2.11 A 2014 -$0.21 A -$0.17 A -$0.14 A $0.04 E -$0.48 E 2015 $0.00 E $0.02 E $0.04 E -$0.02 E $0.04 E 2016 $0.32 E Projected EPS Growth - Next 5 Years % 20 2014 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
OVERVIEW Incorporated in 1959, Houston, Texas-based McDermott International Inc. (MDR) is an engineering and construction company, solely focused on the offshore oil and gas business. McDermott primarily serves the worldwide offshore oil and gas field developments, including the front-end design and detailed engineering, fabrication and installation of offshore drilling and production facilities, as well as installation of marine pipelines and subsea production systems. Additionally, the company provides project management and procurement services. It operates in most major offshore oil and gas producing regions, including the U.S., Mexico, Canada, the Middle East, India, the Caspian Sea and Asia Pacific. In August 2010, McDermott completed the spin-off of its Power Generation Systems and Government Operations segments into a separate, independent and publicly traded company Babcock & Wilcox Co. (BWC). REASONS TO BUY McDermott is a leading global engineering and construction firm that has a diversified product portfolio, specialty manufacturing and service capabilities, and proprietary technological expertise. 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 a complete array of services from design to construction. McDermott has strong presences in most major offshore producing regions around the world, including the U.S., Canada, Mexico, the Middle East, India, the Caspian Sea and Asia Pacific. We have identified the Middle East and Asia Pacific as the key markets in this regard. McDermott s robust backlog, which now stands at $4 billion, not only reflects steady demand from its customers but also offers long-term earnings and cash flow visibility. Order flow and backlog for subsea products and services will continue to be healthy and trend higher in the near future. McDermott, with its strong project execution skills, remains well positioned to receive a large share of offshore construction contracts in 2015. Over the last few years, McDermott has entered into a number of attractive deals that are expected to drive profitability for the company. In particular, the company expects to reap strong benefits from the Inpex Ichthys project. The Inpex Ichthys subsea contract was awarded to the Australian unit of McDermott in early 2012. With an estimated value of $2 billion, this is the biggest subsea contract for McDermott. In particular, McDermott has got significant presence in countries where state-owned entities continue to scout for production growth and new resources. This helps the company to notch up contract wins regularly even in a low commodity price environment. REASONS TO SELL 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. Equity Research MDR Page 2
We believe that the transfer of the power generation and government operations (post-split) has left McDermott with a less diversified business. As a result, the business risk profile of the reorganized McDermott is weaker than that of the predecessor company. McDermott has suspended guidance for the foreseeable future until it pushes ahead with organizational changes. Additionally, the company sees the large Papa Terra project in Brazil contribute to its earnings much later than earlier projections. 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. 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. RECENT NEWS McDermott (MDR) to Work for Ayatsil-A Drilling Platform On Jan 5, 2015, McDermott International declared that it has entered into a deal with Mexico s statecontrolled oil giant Petróleos Mexicanos or PEMEX. Per the agreement, McDermott is expected to install deck, piles and offshore jacket for the Ayatsil-A drilling platform located at Bay of Campeche Ayatsil oil field. The contract s value has been added to the fourth-quarter backlog of McDermott. On 2008, PEMEX discovered the oil field which is believed to increase Mexico s production by roughly 150,000 barrels of oil per day. Since then, this is PEMEX s largest oil field discovery. McDermott added that it got the first track project as it has versatile marine assets which include Derrick Barge 50, heavy-lift vessel, and the Intermac 600 transportation and launch barge. Derrick Barge 50 which is equipped to lift surface loads of 4,400 tons will likely install the 8,400-ton offshore jacket expected to be launched by Intermac 600. Derrick Barge 50 is also anticipated to complete the installation of the deck weighted 3,400-ton and other platform apparatus at water depth of 400 feet. Third Quarter 2014 Results On Nov 5, 2014, McDermott International reported third-quarter 2014 loss of $0.14 per share, wider than the Zacks Consensus Estimate of loss of $0.10. The bottom line, however, came narrower than the yearago loss of $0.27 as operating expenses were much lower. McDermott generated revenues of $414.6 million in the quarter, down almost 40% from the third quarter of 2013. The top line also failed to beat the Zacks Consensus Estimate of $726 million. Decreased project activities hampered the results. Equity Research MDR Page 3
Total Expenses Total costs and expenses decreased 42% to $425.3 million from the year-ago quarter. Backlog At the end of the third quarter, McDermott had a backlog of $3,979.7 million, down from $4,610.7 million a year ago. Balance Sheet Capital expenditure for McDermott during the quarter was $61.6 million. As of Sep 30, 2014, McDermott had cash and cash equivalents of $644 million and long-term debt (including current maturities) of approximately $900.3 million (representing a debt-to-capitalization ratio of approximately 36.2%). VALUATION Overall, we think McDermott is in a better position to weather the current uncertain environment than many of its peers in the engineering and construction space, given its solid backlog position, strong financial health and broad product portfolio. The company s improving award activity, geographic footprint in high-growth regions and continued strong project execution are all positives. However, due to McDermott s exclusive focus on the offshore oil & gas business and the dismal commodity price scenario over the next few quarters, we believe investor sentiment towards the company will remain lukewarm. We further believe that the transfer of the power generation and government operations (post-split) has left McDermott with a less diversified business, thereby heightening its risk profile. These factors are reflected in our continued Neutral recommendation on the company s shares. McDermott s trailing 12-month P/CF multiple is 6.0, compared to the 9.8 average for the peer group and 15.9 for the S&P 500. The company s trailing 12-month EV/EBITDA multiple is negative 2, compared to the industry average of 7.1. Our $3 price objective is based on 6.3X trailing twelve-month cash flow. Equity Research MDR Page 4
Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low McDermott International Inc. (MDR) 71.3 8.9 20.0 6.0 N/A 23.3 7.8 Industry Average 20.7 17.8 15.2 9.8 17.2 133.9 13.0 S&P 500 16.4 15.4 10.7 15.9 18.9 19.4 12.0 Oil States International Inc. (OIS) 13.5 13.2 4.2 9.7 22.6 8.7 Dresser-Rand Group Inc. (DRC) 27.4 24.3 14.9 19.0 32.8 39.2 11.5 Forum Energy Technologies Inc. (FET) 9.5 8.7 20.0 8.0 10.0 21.8 10.0 Matrix Service Co. (MTRX) 13.4 10.9 9.9 14.3 27.9 11.8 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA McDermott International Inc. (MDR) 0.5 3.7 0.5-20.5 0.5 0.0-2.0 Industry Average 1.6 1.6 1.6 8.6 0.5 0.8 7.1 S&P 500 5.1 9.8 3.2 24.8 2.0 Equity Research MDR Page 5
Earnings Surprise and Estimate Revision History Equity Research MDR Page 6
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of MDR. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1105 companies covered: Outperform - 15.3%, Neutral - 78.6%, Underperform 5.8%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research MDR Page 7