In the aftermath of Hurricane Katrina, one of the more common investment theories I've heard is that Americans now know they need new refineries, and that engineering and construction (E&C) companies such as Jacobs Engineering Group
E&C companies provide a full range of services, from initial consulting and design through implementation of large-scale construction projects. They derive revenues from a variety of industry sectors and businesses: oil and gas, power plants, pharmaceutical laboratories, airports, luxury resorts, and just about everything in between. For example, in the latest quarter, the entire oil and gas sector accounted for less than half (about 41%) of Fluor's revenues. While refinery construction would certainly have a positive impact on results, one would be hard-pressed to call E&C companies a "pure play" on refinery construction. Instead, most E&C companies will likely sink or swim based on the overall construction environment.
Furthermore, the chances for new refinery construction in the U.S. are slim. To get an idea of what it takes to build a new refinery, one can look at Arizona Clean Fuels Yuma. This company has been trying to build a new refinery for six years, and not a single shovel of dirt has moved. The company is still fighting its way through city, county, state, and federal permit procedures. Between various levels of government, environmental organizations, and community groups, there are seemingly endless obstacles before construction can begin. Even if the stars align, Arizona Clean Fuels Yuma will not be running until the end of the decade.
Arizona, which has no refineries, is acutely aware of their dependence on fuel from California and Texas. In 2003, a major gasoline pipeline ruptured and was shut down for two weeks, causing price spikes and shortages throughout the state. Partly because of this event, Arizona Clean Fuels Yuma claims that there is 90% public support for a new refinery. Yet it is proving exceptionally difficult for the group to obtain approval for "the most advanced fuel refinery in North America . producing the cleanest burning gasoline, diesel, and jet fuel that can be produced in the United States today." If the cleanest refinery in North America cannot be built in a remote location, with 90% public support within the state, then what are the prospects in the rest of the country?
Americans want lower gasoline prices, and they understand that refining capacity is needed to drive prices down. But few communities would accept a new refinery in their own back yard. I think Americans will support refineries in general but oppose all specific projects, resulting in a stalemate and little or no new construction.
Fortunately for the E&C firms, other catalysts can drive energy-related construction revenues. EPA mandates for clean-burning diesel fuel, refineries upgrading equipment to accept higher-sulfur crude oil, and new refineries being built overseas have helped to propel growth in the oil and gas sector.
In the recent past, the overall construction environment has been favorable, and both Jacobs and Fluor have done well because of heavy construction spending. In Jacobs' case, the market evidently expects the good times to continue to roll. Analysts are projecting earnings of $2.56 for this year, a 13.8% increase over FY 2004. In the most recent quarter, the company's backlog of projects increased 19.7% year over year to $8.4 billion. Jacobs' stock price has risen to $62, resulting in a P/E ratio of 26.3 -- quite a premium for a company with 14% earnings growth.
Fluor is in a slightly weaker (but still positive) financial position, despite a backlog growing at a 21% annual rate. Analysts are projecting earnings of $1.84 for this year, an 18.3% decline over FY 2004. However, revenues and cash flow from operations are expected to increase in 2005, and the company predicts a similar recovery for earnings growth in 2006. Fluor's current P/E ratio of 41 is even higher than Jacobs'.
In contrast to both Jacobs and Fluor, Foster Wheeler continues to lose money despite the favorable construction environment. I don't think Benjamin Graham would find a satisfactory "margin of safety" for any of these three companies.
The Arizona refinery struggle exemplifies one reason why I believe high fuel prices are here to stay for several years: It takes a long time to bring new refining capacity to market. I'm going to continue looking for companies getting oil from deeper in the ocean, farther under the earth, and from non-conventional sources like tar sands. In that light, it might be worth taking another look at the likes of Tesoro
Highly refined further Foolishness:
- The Virtues of Value
- Pricey Gas? Blame Katrina
- In the Wake of Katrina: Refiners and Others
- A True-Blue Value
Fool contributor Robert Aronen owns shares of none of the companies mentioned and wishes Arizona Clean Fuels Yuma the best of luck in its regulatory efforts. Please feel free to share your comments with him.