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Spirit AeroSystems Holdings, Inc. (SPR), Fluor Corporation (NEW) (FLR), McDermott International (MDR): Bad Contracts Can Sometimes Make You Good Money

The calculation assumes expected revenue of $29 billion with an average operating cash flow of $841 million at a 2.9% cash flow margin. This compares to the company’s four-year average margin of 3.2%.

An offshore-construction company’s collapsing contracts
McDermott International (NYSE:MDR)
, an engineering and construction company focused on offshore oil and gas projects, reported a terrible quarter recently. It posted a net loss of $149.4 million, compared to income of $52.7 million a year earlier, with revenue falling abut 27%. The poor showing mainly resulted from some significant project charges and a reduced workload from last year.

The company’s competency at contract management can certainly be called into question. This quarter’s results were decimated by a $62 million write-off on a deepwater project in Malaysia and a $38 million charge to a project in Saudi Arabia. The company’s Atlantic-based operations did not escape unscathed, either, as two contract write-offs there helped crush any chance for profitability.

The Atlantic segment additionally included two projects in Brazil that contributed revenue, but no income, in the quarter. Management noted that the Brazilian projects contain such significant levels of uncertainty that they can’t assume any income from these in 2013.

The good news is that the company has clearly realized its contracting problems. It is taking some significant steps to improve the bidding and execution process. First, McDermott International (NYSE:MDR) is overhauling the leadership of its project delivery teams, bringing in people from outside the company when necessary. It is also setting up project-level incentive plans that more directly align individual compensation with project performance. The company has also increased its focus on bidding for contracts only in areas of the world where it feels like it has the best odds of making money.

Assuming McDermott International (NYSE:MDR) can get its project management issues under control, its share price appears intriguing. Fair business value looks around $11 to $12 a share at a 16 times multiple of operating cash flow, slightly lower than its 2010-2011 average of 18 times. The estimate is predicated on expected revenue of $2.9 billion, with an average operating cash flow of $171 million at a 5.8% cash flow margin. This is discounted from the company’s four-year average margin of 6.8%.

Conclusion
Companies who do business with long-term, fixed-price contracts occasionally have to report large losses from project missteps. These losses aren’t necessarily an indication of how the company will perform in the future, however. Investors might want to look for firms like McDermott International (NYSE:MDR), which has realized its contract mistakes and is implementing solutions. By keenly watching for any sign of a successful turnaround — an improved earnings report or increasing cash flows, for example — an alert stock picker may find these temporarily troubled businesses a compelling investment choice.

The article Bad Contracts Can Sometimes Make You Good Money originally appeared on Fool.com.

Bob Chandler has a long position in McDermott International. The Motley Fool recommends Spirit AeroSystems Holdings (NYSE:SPR). The Motley Fool owns shares of Fluor. 

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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