Don't Walk All Over Fluor
Fluor (FLR: NYSE)
By UBS Investment Research ($121.26, Feb. 15, 2008)
WE ARE UPGRADING Fluor to Buy [from Neutral], reflecting a more attractive valuation, favorable positioning in international and oil and gas markets, as well as some visibility into potential bookings over the next year. The stock has pulled back 28% from its 52-week high on broad macro concerns, and we believe this pullback to a multiple consistent with the range earlier in the cycle provides a favorable entry point, given the continued growth in Fluor's end-markets.
We are reducing our price target to $153 per share, from $165, mainly to reflect a lower market multiple. We apply a 65% premium to the market multiple on our estimate of 2009 earnings, plus $5 per share of cash on the balance sheet.
We believe backlog growth and oil prices are the two most important factors to Fluor's stock. We believe recent bookings of front-end engineering and design projects are leading indicators of and offer some visibility into bookings of future major engineering, procurement and construction (EPC) contracts.
We prefer international and oil and gas exposure, relative to domestic non-energy exposure. At least two-thirds of Fluor's business is oil/gas/power/mining. Roughly 60% of Fluor's backlog at Sept. 30, 2007, was non-U.S., and we believe international energy driven markets are likely to remain favorable for the foreseeable future.
Using calendar year-end stock prices, Fluor outperformed the market in the 1990 recession year, but underperformed in 1991 and 2002. Macro concerns remain a key risk. We note that Fluor outperformed the S&P 500 in the recession year of 1990 (7%) but underperformed in 1991 (down 7%), while slightly underperforming (down 2%) in 2002 (performance calculated using Dec. 31 over Dec. 31 comparison).
We believe the first level of risk for Fluor from slowing economic growth or recession relates to falling commodity prices, particularly oil. At this point, UBS analysts forecast oil in 2008 to decline to $86 per barrel for Brent and $85 for West Texas Intermediate crude, roughly 5%-10% below current levels. While we believe a decline in oil prices could weaken the stock, we do not believe the fundamental project outlook would change noticeably with oil at these levels. Nevertheless, while the stock has pulled back, it is still trading above historical averages, and could weaken in a tough market.
While UBS is calling for recession in the U.S. in the first two quarters of 2008 (down 1% and down 1.5%, in the first and second quarters, respectively), our economists assume a brief and mild recession. Globally, UBS expects gross-domestic-product growth to slow to 3.6% in 2008, from 4.9% in 2007. Notably, GDP growth in China and India is still expected to be 9.9% and 8.2%, respectively. In 2009, global GDP growth is expected to pick up again, to 3.8%, from 3.6% in 2008.
While the market has declined 14% from its 52-week high, Fluor's stock has declined roughly 28%. We believe the underperformance may be attributable to market concerns regarding macroeconomic weakness, which could eventually affect Fluor both directly (less demand for industrial, government and power projects) and indirectly (weaker oil prices, which could threaten spending by oil companies).
However, at this point, we expect oil prices to remain at a sufficiently elevated level to support healthy capital spending in Fluor's major oil and gas end-markets. We also believe Fluor's international exposure position it well for growth despite slowing domestic economic growth.
-- Steven Fisher, CFA
-- Brandon Verblow