Fluor Corporation: Stock Prices Rise (NYSE:FLR)

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Fluor Corporation (FLR) has announced a new copper project in Indonesia. In addition, some opportunities also arise for roads and bridges. In my opinion, the recent transformation of the businesses and the sale of a small part of the company will make it possible to improve the margins of the FCF. Even with conservative sales growth assumptions, the implied valuation is significantly above the current market price. I am long because the downside risk is lower than the upside potential.

Fluor Corporation: Diversified Business Model, New Rewards and Increased Revenue Expectations

Based in Irving, Texas, Fluor Corporation is a multinational engineering and construction company. The business model appears well diversified with multiple business segments: Energy Solutions, Urban Solutions, Mission Solutions, and others. I think FLR will most likely experience significant growth in international markets. Think about it. The company already has a presence in Europe, Asia, the Middle East and Africa, and has a proven business model in North America. As soon as management decides to seriously compete internationally, the target market will grow and sales will most likely head north:

FLR10-k

10-K

In the last quarterly report, management reported beneficial announcements which I must note. First, FLR announced an increase in US Department of Energy activity, which brought new rewards. In my view, if business continues to increase, FLR’s sales growth and FCF margins will increase:

Flour assignments

IR

In the mining and metals and infrastructure sectors, FLR also has a lot to celebrate. The company announced a new copper project in Indonesia. In addition, there are also opportunities for roads, bridges and new projects:

Fluorine mines and metals

IR

Fluoride infrastructure

IR

Putting it all together, the company noted an increase in EPS guidance on the back of modest revenue increases in the Energy, Urban and Mission Solutions segments:

FLR Outlook 2021

IR

Advantageous market estimates and plenty of cash on hand

I’m a bit more pessimistic than most market analysts, as the global engineering services market is expected to grow at a CAGR of 8.1%. In 2022 and 2023, market estimates include sales growth of 10% to 9.2%:

The global engineering services market is expected to grow from $991.38 billion in 2021 to $1071.59 billion in 2022 at a compound annual growth rate (CAGR) of 8.1%. Source: Global Engineering Services Market Report 2022

In terms of EBITDA margin and EBIT margin, analysts are a little more moderate. The EBITDA margin should be close to 2.8% to 3.73%, which is close to my numbers:

Market estimates

Market estimates

Market analysts are also quite optimistic about the company’s free cash flow. Most analysts seem to believe that FCF margins would rise from -4% to 10% in 2022 and 12% in 2023.

Also note that over the next two years, the company’s net debt/EBITDA is expected to decline significantly. I agree with this view. In my opinion, shareholders will be worried about the financial obligations of the company:

Market estimates

Market estimates

I urge readers to exercise due diligence regarding the company’s financial obligations. I did not see many risks. As of September 30, 2021, cash is equal to $2.1 billion and the asset/liability ratio is close to 1x-2x:

Quarterly report

Quarterly report

The company’s long-term debt is equal to $1.1 billion, which seems low. Consider that I expect 2032 free cash flow of $225 million:

Quarterly report

Quarterly report

DCF model under the new strategy “Building a better future”

I am very optimistic about the new strategy “Building a better future” put in place by management in 2021. The change in business model started by changing the composition of the business segments:

During the first quarter of 2021, we changed the composition of our segments to implement our new strategy and seize opportunities in our designated markets. We now report our results of operations as follows: Energy Solutions, Urban Solutions, Mission Solutions and Other. Source: Quarterly Report

Note that the company also intends to invest outside the traditional oil and gas sector. We’re talking about a portfolio of projects involved in energy transition, high-demand metals, infrastructure and mission solutions, among other industries. I believe that the new initiatives will not only bring more diversification, but also sales growth.

Another clear indication of changes within the company’s business model was the sale of the Stork business. This business segment provides asset maintenance and integrity services to the oil and gas, chemical, life sciences, power and other industries. The company intends to sell the majority of its interests in the Stork business in 2022. In my opinion, with the cash from the sale of non-strategic business segments, FLR will be able to invest in new technologies and support sales growth:

We expect to complete the sale of Stork and the remaining AMECO operations later this year or early 2022. Source: Quarterly Report

The global engineering services market is expected to grow at a CAGR of 8.1%, so I used the same sales growth from 2024 to 2032. My results include 2032 revenue of $26 billion. Also, with an EBITDA margin of 6%-3%, 2032 EBITDA would be $807 million, and EBIAT would be $478 million:

My numbers

My numbers

I also assumed D&A of $104-202 million, working capital changes of $148-269 million, and capital expenditures of $96-185 million. I believe my numbers are not far off from the financial statements reported over the past 11 years:

Y-Charts

Y-Charts

Finally, the FCF would increase from $152 million in 2022 to $225 million in 2032. Using a WACC of 8.3%, the net present value is $1.77 billion, or 13 dollars per share. My target price would be near $28 to $32:

My numbers

My numbers

The worst-case scenario would include a probable drop in the price of crude oil

With the The EIA predicts a drop in the price of crude oil in 2022, it is fair to note what this could mean for FLR:

We expect global oil inventories to increase by 0.5 million b/d in 2022, putting downward pressure on crude oil prices. We expect the price of Brent crude oil in 2022 to rise from $79/bbl in the first quarter to $71/bbl in the fourth quarter. Source: EIA

The energy business segment of the company is highly dependent on the price of crude oil and the price of other raw materials. With that in mind, the scenario outlined by the EIA could be catastrophic for the company’s revenue growth:

Due to lower oil prices in the first quarter of 2020, demand for our services in our Energy & Chemicals segment was negatively impacted. There is no guarantee that the current recovery in oil prices will continue, and the timing and extent of any future improvement in demand remains uncertain. The industries served by this segment and many of the others we serve have historically been and will continue to be vulnerable to general downturns, which in turn could materially and adversely affect demand for our services. Source: 10-K

In 2019, the company reported material weaknesses in internal control over financial reporting. I would like to point out that shareholders may suffer from additional shortcomings in the future. In this case, the share price could fall further:

As part of our 2019 year-end assessment of ICFR, we determined that we did not have effective ICFR as of December 31, 2019. We took steps to improve our ICFR and determined that we had effective ICFR effective as of December 31, 2020. If we identify future material weaknesses or are unable to successfully remedy future material weaknesses or other deficiencies in our ICFR, the accuracy and timing of our reports financial resources may be adversely affected, we may be unable to maintain or restore compliance with applicable securities laws. Source: 10-K

There is another very clear risk arising from incorrect assumptions about future economic conditions, future project free cash flows and costs. If FLR realizes that its projects are less profitable than initially expected, FCF’s expectations could drop. As a result, we might see a decline in the company’s valuation:

Incorrect assumptions related to productivity, schedule estimates, or future economic conditions, including the impacts of inflation on fixed price contracts. Source: 10-K

In this scenario, from 2024 to 2032, I expect sales growth of 5 to 2.5%, which would imply sales of $17.8 billion in 2032. Also, with an EBITDA margin close to 3 .2% and an EBIT margin of 2.25%, I got an FCF 2032 of $150 million. With a WACC of 15%, the NPV per share would remain at $9:

My numbers

My numbers

I used exit multiples of 10x-5x, which implied a terminal value per share of $2.7-$1.3 and a target price near $18.5. In my opinion, given the current market price of $20-$23 and the target price obtained in the previous case, the upside potential seems significant:

My numbers

My numbers

Y-Charts

Y-Charts

Conclusion

With significant changes in the company’s business model and a new strategy, I expect FCF margins to move north. If the company continues to invest in energy transition and high-demand metals, FLR will most likely experience sales growth. I’m not as optimistic as other market analysts. However, using conservative market estimates and sales growth, I see significant upside potential in the stock price. My DCF model implied a valuation of $28 to $32. With the current market price of $19-$23, I think the stock is a buy.

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