The Decline of Oil Leaves a Silver Lining

Profit From Other Investors’ Fear

This week’s hot stock operates in the volatile oil and gas industry. As you might expect, its stock price has been beaten down over the past six months by the decline in activity in the industry. However, this price decline is unwarranted, as the underlying fundamentals of this business remain intact. After a decline in revenues in 4Q14, expectations for this stock have been lowered, which allows for the perfect entry point. This company’s high profitability and steady profit growth, when coupled with its stock’s cheap valuation, allow it to earn our Very Attractive rating. This week’s hot stock is Fluor Corporation (FLR).

Fluor Corporation is a global engineering and construction firm that creates and delivers solutions for its engineering, procurement, fabrication, construction, and maintenance clients. The company mainly serves the energy, chemicals, government, industrial, infrastructure, mining and power markets, giving it exposure to numerous income streams. This diversity of markets served gives Fluor the ability to withstand declines in one market as others can make up for the decline. This fact was demonstrated in 2014 as weakness in the Industrial & Infrastructure segment and the government segment was offset by strength in the Oil & Gas and Power segments.

Strength in 2014 allowed Fluor to continue its trend of growing after-tax profit (NOPAT) by a steady 6% compounded annually since 2011. Despite a decline in revenue in 2014 due to large contract awards in 2013 and mining weakness, Fluor’s NOPAT was still up 3% year over year in 2014. The company’s return on invested capital (ROIC) of 27% in 2014 places it in the top quintile of all companies we cover. Fluor also had free cash flow in excess of $859 million at the end of 2014.

The decline in the energy sector seen in the second half of 2014 and into 2015 has caused Fluor’s stock price to drop 26% over the past year. This large decline appears overblown when looking at the company’s robust fundamentals, and FLR is now undervalued. At its current price of ~$57/share, Fluor has a price to economic book value (PEBV) ratio of 0.9. This ratio implies that the market expects Fluor’s NOPAT permanently decline by 10%. While 2015 may be a trying year, management has proven its ability to grow this company and create shareholder value through timely share buybacks. Add in the fact that Fluor recent achieved a record backlog of $42 billion and we feel the current market expectations for this company are overly pessimistic.

If Fluor can grow NOPAT by just 4% compounded annually for the next eight years, the stock is worth $71/share –– a 25% upside.

Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, style, or theme.

Photo Credit: Tim Evanson (Flickr)