McDermott Upgraded to Neutral

On Mar 4, 2013, we upgraded energy-focused engineering and construction firm McDermott International Inc. (MDR - Analyst Report) to Neutral from Underperform, reflecting a balanced risk/reward profile.

Why the Upgrade?

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 2013 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 growing international operations and a solid balance sheet.

Detailed Analysis

McDermott 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. The company’s robust backlog, which now stands at more than $5 billion, not only reflects steady demand from its customers but also offers long-term earnings and cash flow visibility.

McDermott also possesses a solid balance sheet (cash and cash equivalents of $640 million against long-term debt of just over $100 million), which has been a real asset in this highly uncertain period for the economy.

However, we believe these positives are already reflected in its current valuation, so there is not much upside from the current price level.

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 transfer of the power generation and government operations (post-split) has left McDermott with a less diversified business, thereby heightening its risk profile.

Stocks That Warrant a Look

While we expect McDermott to perform in line with its peers and industry levels in the coming months and advice investors to wait for a better entry point before accumulating shares, one can look at Range Resources Corp. (RRC - Analyst Report), Linn Co. LLC (LNCO - Snapshot Report) and Enerplus Corp. (ERF - Snapshot Report) as good buying opportunities. These oil and natural gas explorers – sporting a Zacks Rank #1 (Strong Buy) – have solid secular growth stories with potential to rise significantly from current levels.