Fluor Corp – Price Estimation

Company Overview

Fluor Corp (FLR, Financial) is the U.S.' largest professional services firm providing engineering, procurement, construction, fabrication and modularization, commissioning and maintenance as well as project management services on a global basis. It offers these services independently as well as on a fully integrated basis. Its services can range from basic consulting activities, often at the early stages of a project, to complete design-build contracts.

• In engineering, it applies its areas of expertise to piping, mechanical, electrical, control systems, civil, structural and architectural projects and advanced engineering projects related to process engineering, chemical engineering, simulation, enterprise integration, integrated automation processes and interactive 3-D modeling. Also as part of its services, FLR provides feasibility studies, project development planning, technology evaluation, risk management assessment, global siting, constructability reviews, asset optimization and front-end engineering services.
• FLR's procurement activities consist of supply chain solutions and traditional procurement activities such as strategic sourcing, material management, contracts management, buying, expediting, supplier quality inspections, logistic services and trade compliance services.
• FLR's construction services include mobilizing and executing construction projects on a self-perform or subcontracted basis. Generally, it is responsible for the completion of a project, often in difficult locations and under challenging circumstances. It frequently serves as the primary contractor or subcontractor to other parties.
• Under its operations and maintenance services, it operates and maintains large, complex facilities on behalf of clients. It does this through maintenance services, facility management and turnaround and outage services. Among other things, it provides key management, staffing and management skills to clients on-site at their facilities.
• Under its project management services, FLR is hired to act as project manager on large projects where various contractors and subcontractors are involved and multiple activities need to be integrated to ensure the success of the projects.

FLR serves a diverse set of industries worldwide including oil and gas (42% of revenues), industrial and infrastructure (41% of revenues), government (10% of revenues), global services (2% of revenues), and power (5% of revenues).

Financial highlights

The nature of FLR’s operations is highly cyclical, and this is evident in how the business’ financials fluctuate. In 2013, FLR generated $27,352M in revenues and $668M in earnings. Revenues took a sharp dip in the first 2 quarters of fiscal 2014; this has sent the share price down with it. That being said, the market is still projecting earnings per share of between $3.95 and $4.38 for fiscal 2014 and between $4.75 and $5.50 for fiscal 2015. FLR’s balance sheet also remains strong with a current ratio of 1.8, interest expenses as a share of operating income of less than 2.5% and a long-term debt load (adjusted for operating leases and unfunded pension obligations) that could be paid off with less than 3x average annual earnings. Management is also expected to start being more generous in paying out dividends.

Purchase considerations and reasons for caution

FLR's business operations are highly cyclical. For investors willing to accept some cyclical operating and price risk, FLR's shares can represent a solid play allowing them to benefit from the current upturn in economic activity. The need to build new infrastructure in emerging markets and to replace existing infrastructure in developed markets provides it with some hedge against business cycle volatility. Construction activities in the U.S. and Europe have improved over the last 2 years and this is expected to continue, supporting FLR's growth. The expansion of the alternative energy sector, improved health in the oil and gas sector, and increased investment in the water utilities and electrical utilities sectors will also help support FLR's business for at least the next 10 years.

That being said, FLR faces intense price competition within most of its service lines and any unexpected drop in economic activity or cost overrun on a major project and its profits could be quickly eliminated. Also, due to large government cutbacks in most countries, sales derived from this segment are expected to decline.

Valuation (free cash-flow to equity projections)

A company’s fair value estimate can be calculated as the present value of expected future free cash flows to equity. Free cash flows to equity represent the amount of cash-flows available to common stockholders after all operating expenses, interest and principal payments to lenders have been paid and necessary investments in capital equipment and working capital have been made to maintain and grow operations.

Here we estimate fair value in 5 steps:

1. we forecast the firm’s free cash flows to equity for the next 10 years using econometric processes;

2. we discount those cash flows to the present;

3. we calculate a terminal value for the firm 10 years out based on a long-term expected growth rate and terminal discount rate and discount it to the present;

4. we add the discounted terminal value to the discounted value of free cash flows to equity over the next 10 years; and

5. we divide the present value of all cash flows by the diluted number of shares outstanding.

Free cash flow to equity projections for FLR built using a combination of time-series econometric processes and Monte Carlo Simulation are presented below.

Figure: Free cash flow to equity projections

Valuation (conclusion)

FLR’s per share earnings in 2013 were $4.06. Historical earnings per share grew at an annual rate of approximately 15% per year since 2004. FLR’s sales per share in 2013 were $166.42. We project that sales will grow at a rate of about 4.5% per year between 2014 and 2023. We expect FLR to maintain current margins, interest expenses will remain negligible, and capital expenditures will remain at recent historical levels in the amount of approximately 1% of sales. Assuming a terminal growth rate of 4% and blended long-term discount rate of 9%, our fair value estimate of FLR equals $78.39. At a current price of $69.77, this suggest that FLR is underpriced by about 12%. The question that remains for investors is: is a 12% margin-of-safety sufficient given the business' inherent operating and price risk?