Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

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%.

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

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.

DOWNLOAD FREE REPORT: Warren Buffett's Best Stock Picks

Let Warren Buffett, George Soros, Steve Cohen, and Daniel Loeb WORK FOR YOU.

If you want to beat the low cost index funds by 19 percentage points per year, look no further than our monthly newsletter.In this free report you can find an in-depth analysis of the performance of Warren Buffett's entire historical stock picks. We uncovered Warren Buffett's Best Stock Picks and a way to for Buffett to improve his returns by more than 4 percentage points per year.

Bonus Biotech Stock Pick: You can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12 months.
Subscribe me to Insider Monkey's Free Daily Newsletter
This is a FREE report from Insider Monkey. Credit Card is NOT required.