Drive 1,000 miles north of Seattle and you’ll reach a remote village on the coast of British Columbia. The town of Kitimat isn’t a tourist mecca, but it’s bustling with industrial activity. A massive natural-gas plant and export terminal is under construction—supported by new roads, utilities, pipelines, and other infrastructure. The $32 billion project, under way since 2018, is the largest energy development in Canadian history.
The project could lift earnings for Fluor (ticker: FLR), an American engineering and construction company that has a leading role in it. Construction is 35% complete and, after a delay from Covid-19, on track to be completed by 2024. The project is worth $5.5 billion in revenue to the firm, about 20% of its order backlog. As that revenue rolls in, it could help Fluor hit its target of $3 to $3.50 in earnings per share that year, up from an estimated $1.15 this year.
Investors are skeptical of Fluor hitting that target. That could provide an opportunity in the stock. Indeed, some analysts see the shares, at a recent $16.50, rising 80% over the next year as the company restructures under a new CEO, and revenues get a lift from stimulus spending in the U.S. and a broader industrial recovery.
“It isn’t a short-term trade,” says Vertical Research Partners analyst Michael Dudas, who recently upgraded the stock to a Buy, with a $30 target. “It’s a good combination of cyclical and secular tailwinds and self-help opportunities.”
Fluor’s new CEO, David Constable, took over in January and is now pivoting the firm’s focus. The idea is to reduce reliance on the energy sector, emphasizing growth markets such as mining, petrochemicals, transportation infrastructure, and government services. Fluor, with a market value of $2.5 billion, also does advanced manufacturing for data centers and electronics plants. It’s planning to generate more consistent cash flows and operating margins under new contracting procedures. And it’s aiming to pare debt and sell noncore businesses.
Another lift could be coming from Washington. A major infrastructure bill, while not imminent, would be a win for the engineering sector. Even if it doesn’t pass, stimulus spending for roads, bridges, and other infrastructure could rise under the Biden administration. Fluor is active in transportation projects; it has won bids for nine in its home state of Texas since 2017, including a recent $677 million joint venture around Austin.
The market isn’t giving Fluor much credit for its turnaround plan. The stock slid nearly 7% the day after Fluor presented its strategic update in late January. Fluor executives were vague when pressed by analysts on how they would achieve $3 in EPS. “If it was seen as attainable, the stock would have responded more favorably,” says Baird analyst Andrew Wittmann, who has a Neutral rating on the shares.
Fluor is trying to regain its footing after a number of blunders that cost it credibility. The company for years relied on fixed-price contracts for large projects, absorbing cost overruns. Fluor booked charges and impairments of $1.1 billion in 2019 and an additional $416 million through the first nine months of 2020, mainly related to cost overruns. Fluor also made some ill-timed acquisitions, including an energy maintenance-services company that it is now selling. Fluor has had accounting issues and disclosed a Securities and Exchange Commission probe of its accounting last year. And Constable is the company’s third CEO in two years.
Fluor declined an interview request.
A turnaround appears under way. The company said in January that it’s moving away from fixed-price contracts, aiming to cut them from 47% of projects this year to 25% by 2024, making for more predictable cash flows and potentially higher margins. Fluor completed an internal accounting probe last year, restating financial results and saying it would fix deficiencies, though the SEC investigation is ongoing.
Fluor is seeking growth in areas such as mining for copper and other raw materials for which demand is rising. The company runs a global mining practice for clients such as BHP. Copper prices soared in 2020 and are expected to stay elevated. Capex in global mining is on a multiyear downtrend. But copper supply is expected to fall short of demand as electric-vehicle production ramps up, spurring miners to spend more on expansion projects over the next few years.
“There isn’t much going on now, but there’s optimism that mining companies are dusting off projects and talking to engineering companies to rescope projects in anticipation of supply deficits,” says Mike Sinden, director of metals and mining research at consultancy Wood Mackenzie.
Fluor’s revenues and per-share profits aren’t expected to increase much this year. Its project backlog slipped from $28.4 billion in 2019 to $27.7 billion this year, and it’s likely to stay flat near term, according to Dudas. But he sees it ramping up to $30.7 billion in 2022 as the firm wins projects in a recovery scenario, driven by increased activity in mining, petrochemicals, and government work.
The shares trade at 15 times earnings for 2021, below their average forward multiple of 17 over the past five years. Industrials like Fluor tend to re-rate higher at the start of a commodities cycle, however, as energy and mining projects that were deferred in a downturn get approved with rising prices. The company has also taken steps to reduce operating risk, potentially leading to a higher multiple.
Indeed, Fluor is now selling noncore assets and plans to cut its debt load by $300 million to $500 million over the next couple of years. That should lift the equity value in its capital structure, while reducing interest expense. Its cash position looks healthy with an estimated $2 billion on its balance sheet this year, providing enough working capital to win large projects.
What is it all worth? Dudas arrives at a $30 target, with a multiple of 12 times 2024 earnings of $3.25 a share. That would put the stock at $40. He expects the stock to reach the low $30s over the next 12 to 18 months as Fluor inches toward its 2024 EPS target. “It’s a show-me story,” he says. “But if they can avoid the sins of the past, the market will reward them appropriately.”
Write to Daren Fonda at [email protected]
