McDermott Upgraded to Neutral

We have upgraded energy-focused engineering and construction firm McDermott International ( MDR - Analyst Report ) shares to Neutral from Underperform, while being incrementally more positive on the company.

Incorporated in 1959, McDermott primarily serves the worldwide offshore oil and gas field development activities, including 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 entity The Babcock & Wilcox Company ( BWC - Snapshot Report ) .

Given its geographic footprint in high-growth regions, technology leadership and efficient execution skills, the company is poised to benefit from the strong industry fundamentals for offshore construction activities through 2012 and beyond. We believe order flow and backlog for McDermott’s products and services will continue to be healthy and trend higher in the near-to-medium term.

Additional positives in the McDermott story include continued success on big awards, growing international operations and a solid balance sheet.

However, due to McDermott’s exclusive focus on the offshore oil and gas business and the tentative commodity price outlook 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. Steep operating costs and a slower award environment in 2011 also continues to weigh on McDermott’s results.

As such, we expect the company’s growth potential to be restrained with little room for meaningful upside from current levels. Our new long-term Neutral recommendation is supported by a Zacks #3 Rank (short-term Hold rating).