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Dykstra: McDermott's August Potential

Lenny Dykstra

Today I am once again going to focus on a company in the energy sector, McDermott International(MDR Quote - Cramer on MDR - Stock Picks). McDermott's business is in offshore oil and gas construction, and the company operates in the U.S. and abroad.

As you may recall, in my column on April 2 on Walter Industries(WLT Quote - Cramer on WLT - Stock Picks) I applauded that company's strong return on equity. The ROE provides a great measure for how well a company generates profits.

Though I called Walter's 100% ROE outstanding, McDermott's is well beyond outstanding, at an incredible 215%. This means that for each $1 of equity, McDermott generates $2.15 of profit.

McDermott's stock price took a hit toward the end of February, after the leveraged buyout of TXU Corp.(TXU Quote - Cramer on TXU - Stock Picks). This was because a McDermott subsidiary, the Babcock & Wilcox Company, was notified to suspend performance on five of eight projects in Texas for TXU. McDermott's stock dropped nearly 15% in the following trading sessions. However, this negative movement was an overreaction by the market.

While this suspension has some effect on McDermott in the short term, its overall effect is minimal, as the projects were merely postponed for the time being, and should they be canceled in the future, the contract itself provides for restitution.

Keeping in line with our search for "cheap" companies, McDermott has a PEG (price/earnings-to-growth ratio) of 0.76. The PEG provides a measure of the oft-used P/E ratio to a company's growth. Generally, a PEG for fairly valued company falls between 1 and 2; however, at 0.76 McDermott's stock provides great value for a growing company with strong earnings.

In 2006, McDermott's profit rose to $1.81 per share, up from 59 cents a year ago, and it should continue to rise into the upcoming year. At its present price, the stock is trading with a P/E of 16.37 and a forward P/E of 12.78.

McDermott closed at $49.11 Tuesday, and I suggest buying 10 August 35s (MDRHG) at $13.90. In order to effectively capitalize on the deep-in-the-money calls strategy, I will place a GTC to sell at $1 above my initial cost immediately upon my purchase.

Of course, now that it's Wednesday, that means it's time for my Stat Book, which is below.