While the demand for natural resources has been driven by the need to power emerging markets' growth, it's getting increasingly tougher to full those resources out of the ground. With all the low-hanging fruit plucked, energy stocks must resort to more complex projects -- and lean more heavily on the skills of Fluor(FLR 6.16%), one of the world's largest engineering & construction (E&C) and diversified services companies.
Cash is king
As of the end of fiscal Q2 2013, Fluor has $2.5 billion of cash and marketable securities on its balance sheet, representing approximately one-fifth of its market cap. Conservative investors tend to hail large cash balances as a sign of a strong balance sheet, but I see cash as a strategic tool to create value, too.
First, Fluor operates in a space similar to the high roller rooms in casinos: The bigger the project, the fewer bidders for it. Most companies are not even able to get the entrance ticket to compete with Fluor in its niche of large-scale, multibillion-dollar megaprojects.
Second, horror stories of billion-dollar projects abandoned halfway through construction are nothing new. The global financial crisis has taught companies valuable lessons about the importance of credit quality for both their customers and their vendors. No company will risk its future by awarding its game-changing megaproject to a debt-laden firm offering cheaper rates.
Backlog quality
Investors tend to focus on quantity when assessing companies' order backlog. But if you care more about that backlog's quality, pay close attention to contract type and geographical diversity instead.
Flucor typically lands three types of contracts: fixed-price, cost-reimbursable, and time-and-materials. Fixed-price contracts tend to be higher-margin because of the risk associated with companies footing the bill for unbudgeted costs. In comparison, cost-reimbursable contracts and time-and-materials contracts are usually lower-margin, but with lower risks, given that companies are reimbursed for certain costs based on contract terms.
Fixed-price contracts only account for approximately 16% of Fluor's $37 billion order backlog, with reimbursable contracts making up the rest. This largely minimizes Fluor's financial risk for any cost overrides. Furthermore, Fluor's $37 billion order backlog is well-diversified globally, with no single geographical bloc contributing more than a third of total backlog.
In contrast, some companies may boast of large backlog numbers, but fixed-price contracts and single countries represent the bulk of their order mix.
Order momentum
Fluor won new contracts worth about $7.2 billion in the second quarter of fiscal 2013, which is comparable with new awards amounting to $7.3 billion a year ago. Notable wins this quarter included new scope for a large Russia upstream project in the oil & gas segment, and the expansion of the Cerro Verde copper project in Peru for Freeport-McMoRan, one of the world's largest producers of copper and gold.
The oil & gas segment has traditionally been a key driver of Fluor's top-line and bottom-line growth. For the second quarter of fiscal 2013, this segment represented 40% of revenues. Looking ahead, I expect Fluor to continue benefiting from U.S. shale spending through increased demand for the construction of petrochemical and liquefied natural gas facilities.
Peer comparison
Fluor's E&C peers include Jacobs Engineering (JEC +0.33%) and Foster Wheeler AG (NASDAQ: FWLT).
Jacobs Engineering turned in good results for the third quarter of fiscal 2013, growing both revenues and earnings by about 11%. Its backlog also grew 10% year on year, from $15.6 billion a year ago to $17.2 billion in the most recent quarter. While this looks impressive, I am concerned about Jacobs Engineering's exposure to government clients and its relatively smaller developing-market revenue contribution.
Jacobs Engineering is more vulnerable than Fluor to U.S. government budget cuts. Fluor generated a mere 9% of its most recent quarterly revenues from government customers, while the public sector accounted for 22% of Jacobs Engineering's fiscal 2012 revenues. Also, more than 90% of Jacobs Engineering's 2012 sales come from developing markets (North America & Europe). In contrast, emerging markets in the Asia Pacific, Central and South America , Middle East and Africa represented close to half of Fluor's top line in 2012.
In addition to its core E&C business, which comprises the bulk of its revenues, Foster Wheeler also runs a power equipment supply business. Unlike Fluor, whose clients come from a more diversified range of industries, Foster Wheeler's E&C business has higher concentration of risk, with about 95% of its revenues coming from oil & gas clients. Also, it is worth noting that Foster Wheeler's E&C business has a higher proportion (26%) of fixed-price contracts than Fluor, exposing it to higher financial risk from cost volatility.
Notwithstanding the potential perils mentioned above, Foster Wheeler reported strong earnings growth for the second quarter of 2013, with quarterly adjusted income from continuing operations up by about 62% year over year. Its backlog also remained healthy at approximately $3.3 billion, representing a 4% improvement over last year's second quarter numbers. Foster Wheeler raised its full-year adjusted diluted EPS from continuing operations to above $1.54, but did caution of competitive bidding and delays in both bid invitations and contract award dates.
Conclusion
While Foster Wheeler seems like a contender worth watching, Fluor's strong cash position and backlog quality look even more impressive. Its cash pile gives it an edge in the project bidding process, while its lower proportion of fixed-price contracts lowers financial risk.
