|Survivor A resuscitated Foster Wheeler should benefit from a global building boom|
By JACQUELINE DOHERTY
AFTER A NEAR-DEATH EXPERIENCE, Foster Wheeler, the global engineering and construction outfit, looks much healthier. The timing couldn't be better, coming just as some of its key customers -- in the oil, gas and chemical industries -- appear ready to embark on a global building boom.
The recovery comes after four years in which the company, which builds everything from liquid natural-gas plants to coal-burning boilers, fought to avoid bankruptcy and to restructure its operations and balance sheet.
In the 1990s, Foster Wheeler took on projects that weren't profitable and found itself mired in $1 billion of debt. Its weak financial position hurt its ability to win new work. But now, the company, whose corporate headquarters is in Hamilton, Bermuda, and whose operational hub is Clinton, N.J., has a new capital structure and a risk-management group bent on steering clear of nonprofitable projects.
The company completed a debt-for-equity swap last fall that slashed its debt by $437 million and reduced its interest expense by $28 million annually. The company hopes to arrange a new bank line and relist its stock with a major exchange this quarter. (The shares currently trade over-the-counter, in the "pink sheets.")
As a result of all these changes, Foster has become a much tougher competitor, and its backlog of business -- now $1.8 billion -- should soon begin to grow after declining for years. And, at the least, its downtrodden shares look like a reasonable speculation for those whose investment horizons stretch out a few years.
"It's clear to me we were excluded [from business opportunities] because folks were concerned about our financial viability," says CEO Ray Milchovich. Now, "clients are much more willing to discuss opportunities with us. I believe [the backlog] has already stopped falling. Our intention is to build backlog in 2005."
If he succeeds, the shares could more than double to 30 in the next year or so, estimates Vance Brown, a principal at Spears, Grisanti & Brown, a New York-based investment firm, which owns the stock. The shares have fallen sickeningly, from a high of 957.50 in 1997 to a low of 8.40 in October before climbing to a recent 13. (After the restructuring, the stock underwent a 1-for-20 reverse split.) "There are only a handful of companies that can compete on a worldwide basis, and Foster Wheeler is one of them," he argues.
That said, an investment in Foster Wheeler involves a hearty amount of risk.
The company still has $577 million of debt, more than most of its competitors, in addition to asbestos liabilities and an underfunded pension plan. Its backlog of business has fallen to $1.8 billion at the end of the third quarter, down from more than $6 billion in 2001, hurting revenues and profits.
For the first nine months of 2004, Foster Wheeler posted a loss of $192 million, or $4.60 a share, on $2.1 billion in revenues. The loss includes $175 million of expense from the debt-for-equity swap. The dismal results follow a loss of $91 million, or $1.85 a share, on $2.6 billion of revenues posted for the first nine months of 2003. Milchovich doesn't plan to offer investors 2005 earnings guidance until the second quarter.
Wall Street tends to look at the company on a cash-flow basis, by examining its earnings before interest, taxes, depreciation and amortization, or Ebitda. Based on that measure, Foster Wheeler lost $46 million in the first three quarters of last year. That was much worse than the $41.4 million it racked up in the corresponding 2003 stretch. However, adjusted for charges, Ebitda in the first nine months of 2004 came to $191 million, versus $121.3 million the previous year.
Results aren't expected to improve in 2005. Brown expects cash flow of $160 million to $180 million this year, down from his estimate of $205 million in '04. Andrew Cray, a high-yield research analyst with Imperial Capital -- and the only Wall Street analyst still covering the company -- has similar estimates: $140 million to $180 million in 2005. But, if the company's backlog of business begins to grow this year, as seems quite likely, its operating numbers should improve in 2006 and the stock should benefit. Brown forecasts a modest pickup in Ebitda in 2006, to $200 million.
There are two ways to look at the company. Brown estimates that Foster Wheeler will earn $1.75 to $1.80 a share in 2006, up from $1.25 to $1.35 this year and losses in '04. (Cray's estimate is lower at 85 cents of earnings per share this year.) Competitors in the industry, like Fluor, Shaw Group, Jacobs Engineering Group and Chicago Bridge & Iron, trade with current-year earnings multiples from 19.3 to 20.4 (see table below). If a 20 multiple is applied to Foster's estimated '06 earnings per share, the stock could be worth 35 over the next year or so.
Table: Constructive Outlook
Foster Wheeler shares look cheap versus the competition, if the company's results live up to the
expectations of bulls on the stock.
Market 2005 Enterprise Value
Recent 52-Week Value Rev. Est. Earnings To Trailing
Company Ticker Price High – Low (bil) (bil) Estimate P/E 12-Mo. Ebitda*
Foster Wheeler FWHLF $13.00 $37.40 - $8.40 $0.38 $2.4 $1.30 10.0 4.4
Chicago Bridge & Iron CBI 36.60 41.12 - 21.60 1.68 2.0 1.87 19.6 14.9
Fluor FLR 50.80 55.19 - 36.10 4.26 11.0 2.51 20.2 11.5
Jacobs Engineering** JEC 49.40 49.75 - 36.86 2.78 5.0 2.54 19.4 12.7
Shaw Group*** SGR 16.55 18.15 - 8.89 1.06 3.4 0.81 20.4 10.8
Washington Group Intl WGII 38.22 41.66 - 30.75 0.97 3.1 1.98 19.3 7.4
*Enterprise value is stock-market value, plus cash minus debt. Ebitda is earnings before interest, taxes, depreciation and amortization.
**Fiscal year ends September. ***Fiscal year ends August.
Sources: Thomson Financial/Baseline; Bloomberg; Barron's reports
Alternatively, investors can consider the company's Ebitda multiple. Foster Wheeler has a current enterprise value -- stock-market value, plus cash minus debt -- of only $687 million, or about four times the mid-point of 2005's expected Ebitda. Competitors sport Ebitda multiples of seven to 14 times. If Foster's multiple expanded to seven times $170 million of Ebitda, its shares would be worth 18, a 24% increase from the current level. If Brown's $200 million Ebitda estimate for 2006 is on target, the company could deserve a 10 multiple, which puts the stock closer to 33.
Foster Wheeler has two main divisions: the engineering and construction group and the global power group. The engineering and construction business designs, engineers and constructs oil and gas development projects, petroleum refineries, chemical, petrochemical and pharmaceutical plants, as well as natural- gas liquefaction facilities worldwide. The power group makes and services solid-fuel boilers that burn coal, waste, wood and the like for power stations and industrial markets. It also retrofits plants with pollution-control equipment.
The engineering and construction unit posted $66 million of earnings on $1.3 billion of revenue in the first nine months of 2004. In the same period, the global power group lost $4.7 million on $808 million of revenue.
To regain investors' confidence, Foster Wheeler has to prove that its new risk-management systems will prevent the cost overruns that have darkened the company's past. In the not so-distant bad old days, the company would allow its various offices around the globe to independently bid on new projects. Some did it well. Others, including those in North America, didn't. "They've done a very poor job at the basic blocking and tackling in construction," says Joel Levington, a director at Standard & Poor's. "I don't see any demonstration that they've stabilized their business."
But Milchovich says that things have changed.
The CEO joined Foster Wheeler in late 2001 and, by the second quarter of the following year, the company established a Project Risk Management Group.
Its aim is to review proposals and new contracts from all of the company's offices, determine the potential financial dangers and rewards and decide whether the positives outweigh the negatives. The group is headed by David Wardlaw, who also leads the company's Reading, U.K. office, which boasts no project losses over the past 15 years. Wardlaw reports directly to Milchovich.
"It is their charter to see that we only accept business where we can meet or exceed our clients' expectations and make a return," says Milchovich.
Milchovich: Pushing for a turnaround.
Projects generally have a 3-to-3.5 year life cycle. So, in the third quarter, the company booked cost overruns of $23 million on three European projects that antedated the establishment of the Risk Management Group. The company has said that these projects wouldn't have been accepted under today's guidelines.
The good news is that Foster Wheeler enters 2005 with a backlog that has almost entirely been approved by the risk-management group, leaving only two to three legacy projects under way that management considers risky.
"I'm very bullish on the E&C business. I think we're on the front end of a spending cycle," says Milchovich.
Foster Wheeler's power business boomed in the late 1990s -- the company is a major supplier of boilers -- as construction of utilities, particularly in the U.S., soared on the expectation of dramatic growth in demand for electricity.
Unfortunately, the boom was followed by the bust of the past few years, as electric prices fell sharply (until oil prices began climbing) and construction of new plants came to a halt. This year, the company expects business in this unit to be flat or up slightly.
Foster Wheeler's asbestos-liability exposure stems from the boilers it has installed through the years. While just the mention of asbestos is normally enough to make investors run from a company, in this situation, the claims appear to have peaked. The number of outstanding claims against Foster Wheeler rose from 62,400 in 1998 to 170,860 in 2003, but have remained near that level as the number of new claims has declined and the number of resolved cases has increased.
Foster estimates it has $297.5 million in asbestos liability from existing claims and $214 million from claims it expects to be filed in the next 15 years. That's somewhat offset by the $494 million asbestos-related receivable from insurance companies reported in the third quarter that should cover most of its liabilities from the problem. Foster Wheeler is fortunate to have detailed records -- dating back to the early 1900s -- about where and when boilers were installed and who was present when the work was done.
"The asbestos liability is manageable," says Milchovich. "That's why we did an out-of-[bankruptcy]-court restructuring." Adds Cray of Imperial Capital, "They have a very well-managed asbestos program, where they litigate the majority of cases, and that tends to discourage new claims."
That being said, a New York state trial court ruling earlier this month on Foster's asbestos liabilities surprised the market and caused the stock to sell off slightly. The court ruled that less favorable New York law applies in allocating the level of insurance proceeds available to satisfy asbestos-related bodily injury claims against the company. Foster had calculated its expected insurance recoveries based on more favorable New Jersey law and said it would take a $76 million earnings charge in the fourth quarter (which should reduce its asbestos receivable to $418 million) to reflect an increase in payments it might have to make from 2010 to 2019. The company says it will appeal the decision.
Foster also has an underfunded pension plan that will require contributions of about $20 million a year. However, the domestic defined-benefit plan was frozen in 2003, so no future benefits will be granted and there are no new entrants being accepted.
Other major players in the industry have watched their stocks soar over the past year. Fluor shares have rallied 42% since last January, while Shaw Group is up 37%.
If Foster Wheeler can rebuild its backlog over the next year, investors' confidence should grow. The effect on its shares should be constructive.
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