Raising KBR estimates and price target on strong industry backdrop June 07, 2007
Goldman Sachs' Rating/Coverage View is Neutral/Neutral
What's changed
We are raising our earnings estimates and increasing our 6-month price target on KBR shares to $28 from $22. Since May 6, 2007 KBR shares and our broader E&C stock coverage universe have increased 25% and 15%, respectively. Several E&C companies reported strong 1Q earnings in May, with results generally exceeding expectations due to margin expansion that was on average 50 bp better than our forecasts. Engineering supply constraints appear to be enabling significantly better pricing and contract terms, suggesting upside to longer-term earnings estimates and supporting higher valuation multiples.
Implications
We are raising our KBR target multiple to 20x our normalized earnings estimate (up from 17x), accounting for $4 of the total $6 increase to our price target. The remainder reflects an upward revision of our normalized EPS estimate to $1.42 from $1.25, primarily driven by our assumption of less near-term tailoff of Iraq military services revenue. We are maintaining our Neutral rating, however, following the recent run in the shares, which already appear to reflect much of the good news from the industry. We currently see other E&C names with more compelling risk/reward including Foster Wheeler, Chicago Bridge & Iron, and Jacobs Engineering.
Valuation
Our 6-month price target of $28 is based on comparative valuation, normalized earnings, and our correlation of EV/IC versus ROIC in our E&C coverage universe.
Key risks
Key risks to the downside include lower energy prices, a lack of new award activity, cost overruns on fixed-price contracts, and larger than expected decline in Middle East revenue. Risks to the upside include greater than expected new award activity and/or revenue from military services. |
