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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Low Oil Prices Make This Stock A Good Long-Term Bet

Things have rarely looked so bad for Fluor and the construction management services industry in general. Unlike some other firms in the industry (e.g. KBR and McDermott), Fluor has a history of being a well-run company with an effective management team that rarely makes serious mistakes. FLR is not burdened by the same (overblown) concerns regarding nuclear contracts that Chicago Bridge and Iron faces, and the firm has better economies of scale than smaller peer Jacobs Engineering. Despite all this, Fluor has fallen mightily of late, capped by a nearly 10 percent decline after announcing earnings on July 30.

With the stock now near a 52-week low and trading at levels not seen since the first Euro Crisis of 2011, investors have to ask themselves how to respond. If history is any indication, the collapse of FLR’s stock represents an excellent long-term opportunity albeit with some short-term pain. On average, stocks that see significant negative price shocks after earnings represent good long-term opportunities for investors. Related: Nuclear Industry Future Far From Clear

Another 10 percent fall in the price would take the stock back to the same type of levels seen during the Great Recession. Fluor is forecasting earnings per share of a little over $4 for 2015, but the larger issue for investors is what happens in 2016 and beyond. Fluor, like the rest of its competitors, has benefitted strongly from the new energy infrastructure boom. From Ethylene Crackers to major mining projects, the last decade’s commodities boom has been key to Fluor’s earnings growth. Now commodities have tumbled, on the back of paper-tiger superpower China’s slowing growth, and the oil price collapse is adding insult to injury for FLR and all its peers.

Fluor’s earnings next year probably won’t decline to the same degree that many energy firms’ will, but it is clear that the company is going to face substantial headwinds for a while. The firm provides good value at today’s levels. Many tech companies, and even the broader stock market as a whole, are arguably slightly overpriced. The same cannot be said for FLR or any of the other firms linked to the commodities complex. FLR is trading at roughly 10X cash flow from operations based on its most recent results. Related: How Russia’s Energy Giant Imploded

FLR management has been particularly vocal in expressing disappointment on the non-oil and gas side, but that’s not new news. Instead, the oil and gas collapse is likely to be an ongoing shock for the firm for a couple of years. For long-term investors though, Fluor should definitely be on the radar. The company is a quality operation with good management and a solid reputation. The nature of its business is one of booms and busts, but even as revenues have come down, FLR has restructured and cut its own supply chain costs leading to higher profit margins this year than in the past.

Fluor is still winning business, and the firm has a low level of debt, so the firm is not at serious risk of financial distress. But Fluor is not the type of business that pays a big dividend yield, and given the macroeconomic clouds around the company, it’s going to take a while before investors are comfortable enough with the outlook to start bidding up the price again. Related: Could WTI Trade At A Premium To Brent By Next Year?

As a long-term holding, FLR offers great value then, but investors buying in at this stage need a strong stomach as the worst is probably still to come. Financial principles indicate that higher returns require higher risk, and FLR has definitely moved up a notch in both the risk and return space.

By Michael McDonald for Oilprice.com

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