NEW YORK ( MagicDiligence.com) -- One useful exercise when scanning the Magic Formula® Investing screens is comparative analysis of stocks in the same sector, or stocks that are direct competitors. (This link takes you to magicformulainvesting.com.)
MFI is as much of a sector-ranking tool as it is for individual stocks. It is common to see many companies from the same industry sector enter the screen at almost the same time, as macro-economic factors weigh on all participants. A few examples currently: For-profit education ( Apollo ( APOL), Capella ( CPLA), ITT ( ESI) and DeVry ( DV)); semiconductors ( KLA-Tencor ( KLAC), Kulicke & Soffa ( KLIC) and Marvell ( MRVL)); and defense ( Raytheon ( RTN), General Dynamics ( GD) and SAIC ( SAI), among others). (Company names link to magicformulainvesting.com.) For this article, we'll focus on a smaller set: engineering and construction companies. While in the past there have been more, right now there are two E&C companies in the screen: Fluor ( FLR) and Foster Wheeler ( FWLT). (Company names link to magicformulainvesting.com.) Which one would be a better choice for an investor wanting exposure into the E&C sector?
The E&C business model is relatively easy to understand at the sketch level. These companies bid on jobs for new construction, procurement, engineering and maintenance for facilities to a wide variety of customers. Contracts can be on a fixed-cost basis (the E&C firm offers to do the job for a set price) or "cost-plus", where pricing is determined by an agreed-upon markup on project costs. Some E&C firms also concentrate on winning maintenance contracts, which provides a nice stream of recurring revenues. Fluor and Foster Wheeler both do a large amount of business for the oil and gas industry, although FWLT is far more concentrated there (nearly 80% of sales vs. 34% for FLR). The bulk of these jobs involve building, upgrading or maintaining refineries. Foster Wheeler also has a sizable business (20% of sales) building fuel boilers that are used in electric power plants. These boilers allow the power plant to burn a range of fuels from coal, oil, gas, biomass and even waste products. Fluor, on the other hand, is far more diversified. 41% of sales come from the industrial and infrastructure segment, with projects in mining, transportation, health care, telecom, and other end customers. Government (15%) services the Departments of Energy, Defense and Homeland Security, with two major ongoing contracts at the DoE's Savannah River nuclear site, and the DoD's LOGCAP IV military logistics contract in Afghanistan. 7% of sales are from the services unit, and another 3% from electric power customers.
Both firms are in very good financial health. FWLT carries 4 times as much cash on the balance sheet as debt, while for FLR the ratio is 5 times. Both companies have current ratios (current assets/current liabilities) around 1.4, and both earn more interest than they pay out. Both firms consistently generate free cash flows margins of 3%-5% on sales. FWLT's 5-year average return on invested capital is about 32%, and FLR's is almost exactly the same! Financial health is excellent for both companies; in this comparison, we have an even push.
These two firms approach the return of capital to shareholders slightly differently. Foster Wheeler concentrates on share buybacks, and it has been aggressive, with an average share count decline of 5.7% per year since 2007. Fluor buys back shares too, but to a lesser extent, with an average 1.2% annual reduction in the same period. On the other hand, Fluor also pays a 1.3% annual dividend yield, while Foster Wheeler pays none. Another close call here, but Fluor gets a slight nod for committing to a regular dividend.
Fluor has performed better from a growth standpoint than Foster Wheeler over the past 5 years, with a compound annual revenue growth (CAGR) rate of 8%, while Foster's sales have actually declined. Additionally, recent trends favor Fluor, with that company reporting a 14% increase in backlog in the most recent quarter, vs. a 7% decline for Foster Wheeler.