KBR Continues To Face Macro Challenges: Should You Hold?

Prolonged softness in the energy-related markets has severely crippled the growth potential of companies operating in this domain. Over the past six months, premium engineering, procurement, and construction company, KBR, Inc.’s (NYSE:KBR) shares recorded an average return of 10.5%, underperforming the Zacks categorized Engineering/R&D Services industry average of 14.3%.

KBR has managed to beat estimates twice for the trailing four quarters, boasting an average positive earnings surprise of 3.9%. However, the company’s earnings estimates have moved south in the past couple of months. Analysts have become increasingly bearish on the stock, as they have revised the Zacks Consensus Estimate for fiscal 2016 earnings downward in the past 60 days, from $1.33 to $1.17, a move of 12.0%.

What’s Thwarting Growth?

Reduced capital budget of clients and lower operational expenditure budgets over the past few quarters have largely thwarted the company’s growth momentum. Volatile oil and gas markets, with oversupply continuing to strain the prices and spending levels, have marred KBR’s projects and orders.

Revenues were down 10.5% year over year to $1,073 million during third-quarter 2016, hit by depressed oil prices. As a matter of fact, over the eight quarters, the company recorded precipitous decline in revenues, largely attributable to macroeconomic woes. In addition to this, foreign currency fluctuations have been impacting the company’s backlog levels. Moreover, slower activity on the LNG project in Australia as well as reduced capital expenditure by key clients including Pemex, have been weighing on the company’s profits.

About a year ago, the company had three EPC power plants under construction, which is now down to one. In addition, a large LNG project in Australia, which is approaching completion, is likely to hurt the Engineering and Construction segment’s revenues. Going forward, we expect softness in the energy related markets to affect both Engineering & Construction and Technology & Consulting businesses for the rest of fiscal 2016, thus weighing down on the company’s financials.

Silver Lining

Despite tough times, we believe that the company’s Government Services business will continue to act as a key profit churner for the upcoming quarters, battling some of these headwinds. Government services work, which is mostly low risk, helps in reducing volatility associated with the bottom line. This apart, the company’s solid prospects in the hydrocarbon projects are adding to its strength. A healthy balance between hydrocarbon and government projects will enable KBR to offset the softness in Engineering and Construction segment, boosting growth.

Additionally, the company’s recently completed acquisitions, namely Wyle Inc. and Honeywell International Inc.’s (NYSE:HON) technology development and engineering unit – Honeywell Technology Solutions, Inc. ("HTSI") – are proving conducive to the growth of the company’s Government business. Particularly, the acquisition of HTSI has assisted KBR to expand lifecycle service capabilities, such as cyber security and IT expertise, enabling it to take care of all the steps involved in the life cycle of aerospace and defense programs.

Further, it unlocks opportunities to foray into new services in the aerospace logistics and intelligence domain. These acquisitions contributed $200 million to the Government Services revenues during the fiscal third quarter.

Zacks Rank and Stocks to Consider

KBR currently carries a Zacks Rank #3 (Hold).Better-ranked stocks in the industry include Applied Industrial Technologies, Inc. (NYSE:AIT) and Middleby Corporation (NASDAQ:MIDD) . Both the stocks currently hold a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Applied Industrial Technologies managed to beat estimates thrice over the trailing four quarters and has a positive earnings surprise of 4.9%.

Middleby Corporation beat earnings in each of the trailing four quarters, resulting in an average surprise of 15.9%.

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