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On Jan 22, 2014 we maintained our Neutral recommendation on KBR Inc. (KBR) owing to concerns about the company’s sluggish third-quarter earnings performance.

However, the company is expected to benefit from potential in the LNG market, thanks to the shale gas revolution. Nevertheless, we are concerned about the company’s drop in year-over-year revenue due to low project activity.

Why the Reiteration?

On Oct 29, 2013, KBR posted third-quarter 2013 net income and earnings per share of $24 million and 16 cents respectively. This was a great improvement upon the year-ago quarter’s net loss of $81 million or 55 cents per share. However, earnings fell way short of the Zacks Consensus Estimate of 71 cents.

Revenues came in at $1.8 billion compared with $2.0 billion in the third quarter of 2012. These were also 10% lower than the Zacks Consensus Estimate of $2.0 billion.

However, in the last 90 days since the company reported its third-quarter earnings, the estimates for both fiscal 2013 and 2014 have declined sharply. In the last 90 days, the Zacks Consensus Estimate for 2013 declined 5.6% to $2.52 and for 2014; the estimates declined 11.3% to $2.76 a share. 

The surge in shale gas revolution in North America is generating promising opportunities for Liquefied Natural Gas (LNG), ammonia and ethylene projects. KBR is benefiting from this potential in the LNG market and has been receiving a steady inflow of orders from the world’s largest refineries as well as oil and gas facilities.

Given the nature of KBR’s operations, which primarily include long-cycle projects, the company's robust backlog lends visibility to its future revenue stream.

At the end of the third quarter, the company had a backlog of $14.2 billion, reflecting an increase of 2.9% sequentially.

However, KBR’s contracts are usually long-cycle in nature. The business is dependent upon major construction projects or front end engineering and design (FEED) contracts which take long to complete. Therefore, unpredictable timing between the contract win and payment results in fluctuations in cash flow and earnings.

This apart, KBR operates in a highly competitive environment among companies that enjoy a strong brand name and reputation in the energy, oil & gas and Industrials segments. In order to keep up with its competitors, KBR needs to be constantly updated about state-of-the-art construction procedures.

Currently, KBR retains a Zacks Rank #4 (Sell). However, some better-ranked energy and utility stocks include Fluor Corp. (FLR - Analyst Report), Quanta Services Inc. (PWR - Analyst Report) and Crane Co. (CR - Snapshot Report). All three carry a Zacks Rank #2 (Buy).

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