McDermott Cut to Underperform

Given its erratic earnings trend over the last few quarters and a disappointing outlook for 2013, we have downgraded the shares of energy-focused engineering and construction firm McDermott International ( MDR - Analyst Report ) to Underperform from Neutral.

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 ) .

Though the energy-focused engineering and construction firm managed to beat revenue estimates in the most recent quarter, it had to deal with steeper operating costs. McDermott has already hinted that its top line will suffer next year due to uncertainty regarding the timing of big awards.

Near-term bookings also remain lumpy, as the current uncertain environment has hurt the economics of building new oil and gas infrastructure.

Moreover, 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 its earlier form.

Given these concerns, we expect McDermott to perform below its peers and industry levels in the coming months. As such, we see little reason for investors to own the stock. Our new long-term Underperform recommendation is supported by a Zacks #5 Rank (short-term Strong Sell rating).

Partially offsetting these negatives are the company’s solid margins, clean execution skills and expectations for accelerated activity levels next year.