MDR McDermott International Inc

Energy-focused engineering and construction company  McDermott International (MDR) has reported mixed second quarter 2011 earnings following improved sales and higher operating costs.

The company reported earnings per share from continuing operations of 27 cents in the quarter, lagging the Zacks Consensus Estimate of 32 cents and deteriorating 20.6% from 34 cents earned in the prior-year quarter. The underperformance can be attributed to weaker marine operations in the Middle East business unit.

McDermott generated revenues of $849.8 million in the quarter, up a whopping 35.5% from second quarter 2010 and slightly ahead of our expectation of $841 million. The quarterly performance was buoyed by strong contributions from the Asia-Pacific belt (attributable to increased marine activity on large engineering, procurement, construction and installation or EPCI projects), partially offset by weak activity in the Middle East region.

During the quarter, the company’s operating income plunged 14.6% year over year to $83.8 million, adversely affected by higher operating expenses.

Backlog

At the end of the quarter, McDermott had a backlog of $4.7 billion, compared with $4.2 billion in the prior year. As of March 31, 2011, backlog was $4.8 billion.

Balance Sheet

As of June 30, 2011, the company had $301.9 million cash on hand and long-term debt (including current maturities) of $81.9 million, representing a debt-to-capitalization ratio of 4.6%.

Our Recommendation

We believe that Houston, Texas-based McDermott will reap benefits of strong industry fundamentals through 2011 and beyond, given its geographic footprint in high-growth regions, as well as its technology leadership and efficient execution skills. The order flow and backlog for the company’s products and services are expected to remain healthy and trend higher in the near-to-medium term.

However, following The Babcock & Wilcox Company (BWC) spin off, McDermott has transformed into a less diversified concern with a greater business risk profile. Moreover, the company remains exposed to the highly volatile oil and gas fundamentals and commodity price fluctuations. Hence, we see limited upside potential for the stock and maintain our long-term Neutral recommendation.

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