MDR: Is It Too Big to Go Down.

Bankruptcy

Truth is that the word ‘bankruptcy’ never sounds good to any investor however, it’s also largely misinformed to rule out the possibility of a company going through bankruptcy to come out of it in a better financial position that it was before.

Exactly in the last day of last year, news and speculations of McDermott International Inc. (MDR) filing for bankruptcy started circulating. Within no time the news which emanated from WSJ and Bloomberg had spread far and wide. It’s more than evident the procurement and construction company serving the oil and gas sector has been experiencing financial distress in recent times and if the rumors are anything to go by, this will for sure have propelled the firm into bankruptcy.

According to dependable sources, several lenders led by HPS Investment Partners and Baupost Group LLC will be providing McDermott with a $2 Billion bankruptcy loan. The firm is intending to use the loan to finance its operational costs.

Despite that McDermott is yet to comment about these claims, I think it would be naive to say the company is far from a bankruptcy situation.

This situation leave investors with tough choices to me made; do they rule out the stock and get out or do they get out and get back in perhaps when things start looking better once again. Things even get harder considering the fact that markets are rating McDermott as neutral, which in my view suggests a hold.

A Bumpy 2019

In the just concluded 2019, McDermott had three quarterly reports which to point out all recorded net losses all through.

Q1 Summary Results

MDR Q1 2019
New awards of $6.7 Billion
Book-to-bill ratio of 3.0x
41% sequential-quarter increase in backlog $15.4 Billion
Revenues $2.2 Billion
Net loss $70 million or $(0.39) per diluted share
Operating income $13 million
Operating activities $(244) million

For the first quarter the company attributed the net $70 million net loss to restructuring, integration and transactions costs.

“As for the company’s performance in the first quarter of 2019, the net loss of $(70) million was largely the result of $73 million of restructuring, integration and transaction costs, which also impacted operating income, offsetting otherwise sound performance across our operating segments and a sequential-quarter reduction in selling, general and administrative expenses,” said President and CEO of McDermott David Dickson.

 

Q2 Summary Results

MDR Q2 2019
New awards $7.3 Billion
Book-to-bill ratio of 3.4x
34% sequential-quarter increase in backlog to $21 Billion
Revenues $2.1 Billion
Net loss $146 million or $(0.80) per diluted share
Adjusted operating income $71 million

 

In the second quarter the company used $205 million on operating activities which it attributed to the net loss and usage of cash on the Cameron LNG project.

Q3 Summary Results

MDR Q3 2019
New awards $1.7 Billion
Backlog $20.1 Billion
Revenues $2.1 Billion
Net losses $1.9 Billion or $(10.37) per diluted share
Operating loss $1.7 Billion

 

The company pinned the loss in the third quarter to asset impairments and project charges i.e. $1.5 Billion goodwill and intangible assets impairments in addition to $256 Million of changes in project gross profit on specified projects.

On October 21, 2019 McDermott secured a $1.7 Billion financing agreement from its first-lien lenders. “Our recently announced $1.7 billion financing agreement with our lenders signals their confidence in our underlying business. We continue working with them to achieve a long-term balance sheet solution as we remain focused on delivering value for our customers, employees, subcontractors, and suppliers.” said the CEO. We elected to enter into the 30-day grace period with respect to a November 1, 2019 interest payment on our 10.625% senior notes due in 2024 in order to continue collaborative discussions with our lenders and note holders to find a long-term balance sheet solution.” added the CEO.

The company also pointed out to a continuation of prior announced strategic alternatives process for its litmus technology business and the sale process for the remaining bit of its pipe fabrication business.

Note: I extracted above quarterly data from McDermott Investors website. I only picked out the data I deemed useful for this analysis, you can get the complete quarterly results from the website.

 

The Bankruptcy Dilemma

From the above data sets, not only did McDermott report losses all through the year but also it posted new awards and massive backlogs in the entire year.

To begin with, why are the institutions continuously awarding the company more and more contracts if there is a real danger of an incoming bankruptcy?

Concerning the massive backlogs, if the firms finally files for bankruptcy, then it means the $20.1 Billion backlogs will have to be suspended and possibly retendered. This will be a lengthily process which I don’t know how long it will take.

Despite the turbulent times, McDermott appears to be the largest offshore ECPI Company among its peers in the sense that, it’s the only company in the oil and gas industry which has the skills and required experience to comfortably, efficiently and profitably execute LNG projects.

In any unfortunate event that the firm suspends these massive backlogs, it’s highly questionable if its competitors are able to carry out the LNG contracts successfully without any hitches.

Another point worth capturing, in October the firm obtained $1.7 Billion from its trusted lenders. It’s quite obvious that before any lending a meticulous financial diligence must be carried out to determine the credit worthiness of the borrower. I believe this happened, so if there was a possibility of an imminent bankruptcy why would the lenders loan the firm the $1.7 Billion?

 

With extensive analysis of company’s the quarterly reports for last year you will note the McDermott successfully Freeport and Cameron LNG projects. In addition, the company hints at being close to selling its Lummus Technology business at a cost of $2.5 Billion, which I think it’s enough to keep the company off liquidity.

Fundamental Analysis

The data below can be used to further get a clearer picture of McDermott’s financial situation.

Ratio nameNumberIndustry’s average
Return on Assets-51.10%3.27%
F-score4
Profit margin-57.10%4.88%
Revenue growth59.67%
EPS-361.84%
Debt/Equity ratio0
Current ratio0.41.83
Altman-Z score-2.412.08
Forward P/E ratio-0.87

Data Source: fivniz.com

  • MDR is having a ROA of -52.10% definitely it’s much below 3.27% which is the industry’s average. MDR’s ROA is the lowest of all the listed companies in oil and gas industry.
  • Since the F-score runs on a scale of 0 to 9 It’s only fair to rate MDR’s (4) to be in an average and profitable financial position.
  • MDR records a way low profit margin (-57.10%) in comparison to the industry’s average of 3.27%. All industry peers outperformed MDR.
  • In 2019 MDR posted a revenue growth of 59.67%, a very remarkable growth rate indeed in comparison to the industrial average of 4.88%. In fact in the last five years, MDR revenue has been growing by an average of 30%.
  • The EPS of MDR declined by -361.84% in 2019 symbolizing a very strong negative growth in EPS.
  • Despite everything MDR managed to post a Debt/Equity ratio of 0. Such a performance places MDR among best performing companies in the industry since the performance is better than that of 90% of its industry peers.
  • MDR’s current ratio of 0.4 which is way lower than the industry’s average 1.83 probably insinuates the company will encounter problems meeting its short term financial obligations.
  • Without a doubt the negative Altman-Z score puts the company at a place of very high risk of bankruptcy.

My Take  

It is from the above analysis that I get to understand why markets analysts are giving McDermott a neutral rating.

With reference to all data captured above, it’s evident to say MDR will have difficult times in meeting its financial obligations in the short term.

However, we must ask ourselves is it rational enough to rule out an industry leader like McDermott based on its current temporary situation? Is this situation worse enough to warrant for bankruptcy?

With reference to data from MDR’s balance sheet the company has a $1 billion negative net worth i.e. a negative shareholder’s equity. I think excess illiquid assets held by MDR are the major contributor to the negative shareholder’s equity. The firm seems to be tying up much of its borrowed cash in plant and machinery.

Another factor which can’t be overlooked is the fact that the company has been posting consistent growth in the last 5 years. At times when a company is expanding too much than its cash resources needed to fund the growth financial distress is always inevitable. With the case of MDR this might be very possible considering the fact that it’s the only company which can carry out LNG contracts efficiently.

Bankruptcy is a complex and quite a lengthily process which comes with so many risks including the risk of the same issue resurfacing back after the company has come out of the bankruptcy situation.

I strongly believe that top executives in McDermott are seriously looking at every possible solution to avoid a bankruptcy situation.

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