Share tip of the week: Construction firm in line for windfall

By Paul Hill Jul 31, 2009

Paul Hill

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When Barack Obama first announced his $787bn stimulus package, investors piled into US engineering and construction stocks, attracted by the $120bn windfall assigned to domestic infrastructure.

But seven months later there have been few contracts awarded, pushing prices south. Funding of these capital-intensive projects has stalled because many states (not just California) have big budget deficits. The good news is that these local issues are being side-stepped with finance provided by consortiums along the lines of UK-style public-private partnerships.

So engineering and construction groups like Foster Wheeler should benefit as the money is deployed in the next two years. Foster specialises in the oil and gas, power generation and chemical areas.

These have suffered in the recession, yet the firm still sports a $4.9bn order book and is landing new business at a decent rate. Recent orders include one from Eon in the UK to build a new carbon capture plant, and another from Santos in Australia for extracting coal-seam gas. It also has a pristine balance sheet, with a $567m cash hoard, albeit slightly offset by a $315m pension deficit and a net $67m exposure to asbestos liabilities.

Foster Wheeler (Nasdaq: FWLT), rated a BUY by Broadpoint

So why have the shares fallen over 70% in the past 18 months, to a 2008 p/e of 6.3? First, the bursting of the oil bubble last year crushed sentiment towards these stocks. But with crude prices back to about $60-$70 a barrel, the industry's fundamentals have improved, despite the potential drag from future project delays and cancellations. Lesser concerns include growing competition and the impact of a stronger dollar, as much of the order book comes from outside the US.

But these dangers have been more than priced into the downtrodden share price. Wall Street expects 2009 turnover and underlying operating profits (Ebita) of $5.3bn and $420m respectively – putting the stock on a bottom-of-the-cycle combined enterprise value (EV) and Ebita rating of less than six. I'd value the group on an eight times multiple. Adjusting for the cash pile and assuming sustainable profit margins of 8%, this generates an intrinsic worth of around $31 a share. In all, Foster's long-term prospects are bright. Pent-up demand for urgent infrastructure projects in the US alone is worth trillions of dollars over the next decade. Second quarter results are due on 5 August.

Recommendation: long-term BUY at $22.00

• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments

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