Description

In our view, FLR is exceedingly cheap (5.7x 2024 EPS) and materially undervalued, with the backlog inflecting positively, a mix shift which should garner a higher multiple, and value unlocked from FLR’s $1.9bn SPAC of its NuScale subsidiary. We know the pushback. Life is too short to invest in an E&C – I don’t care how cheap it is, all E&Cs have backlog/cost problems. In this instance, we think the risk can be siloed, the inflection in the business is real, the operational turnaround has been substantially de-risked, and the downside protection provided by the value of the NuScale subsidiary is substantial. We think the stock is a ~double from here with a favorable up/down skew (of at least 2:1).

FLR is a full-service engineering and construction (“E&C”) firm. It can build small factories, bridges, roads, chemical plants, mines, etc. It can also provide operations and maintenance services.

First, a history lesson.

FLR is in the 8th inning of its turnaround story.

From 2002 to 2011, FLR was led by then-CEO Alan Boeckmann and saw its share price go up ~400% as the Company solidified its position as an E&C powerhouse. In 2011, Boeckmann handed the reins to David Seaton who was CEO from 2011 to spring 2019; under his leadership the Company was encouraged to take on bigger, fixed price contracts which he thought would lead to higher margins. The business started unraveling in late 2018 through 2019 as the Company was forced to take charges on said projects which demonstrated the quality controls in project underwriting had broken down.

Alan Boeckmann returned as Executive Chairman in May 2019, and on his first day had Seaton fired. Boeckmann then later brought on David Constable as CEO - Constable is a former FLR exec who was Boeckmann’s second choice in 2011 that was ultimately passed over in favor of Seaton.

Now that the history lesson is over, let’s get to the bull case on FLR:

1. FLR is taking its small modular reactor business, NuScale, public through a SPAC. What was -$540mm of value in analyst price targets (~$90mm EBITDA loss capitalized at 5.5-6.5x) is actually worth $1.4bn ($8/sh)

2. Company has an overly conservative and below mid-cycle 2024 EPS target of $2.50-2.90 vs. consensus $1.16 in 2022 - these targets assume no earnings or capital from NuScale

3. The business has largely churned its projects underwritten by prior management, and while there is a “wall of worry” around one large outstanding project (LNG Canada), our checks indicate this project is still progressing well with a substantial untapped contingency

4. The Company is shifting its business mix which should garner a higher multiple

1. 45% cost plus in 3Q19 → 65% in 2022 (already locked down w/ large new project) → 75% in 2024. 90% of near-term bidding is on cost-plus projects

2. Shifting from traditional O&G to “sexy” new areas like energy transition and advanced manufacturing facilities

5. Book to bill is about to inflect >1x and we believe we are entering a capex supercycle, with management talking about unheard of bidding activity. The infrastructure bill in particular will be meaningful

6. Competitive landscape has materially changed: Jacobs sold Energy/Chemicals to Worley, AECOM in process of divesting at-risk construction business, MDR bankruptcy. Bechtel and FLR are the remaining market leaders

7. Exceedingly cheap stock at 5.7-6.6x management’s 2024 targets after backing out NuScale stake

8. Unloved by sellside with 9 holds and 1 buy

9. Why now: 1) NuScale SPAC closing in 2Q22; 2) book/bill inflection; 3) the Company has indicated it is targeting very large projects in 1H22; 4) positive LNG Canada updates

10. Additional call options - FLR has various other green technologies that it sells, such as its leading carbon capture technology. There’s no reason it couldn’t carve this out

Current valuation + base case returns:

NuScale:

Let’s start with NuScale. We could do an entire write-up on NuScale, but we’ll keep this brief.

NuScale is a small modular reactor (“SMR”) company that is going public through the Spring Valley (ticker: SV) SPAC. More specifically, it is the only company to have an SMR with an approved design from the US Nuclear Regulatory Commission (“NRC”) - our work suggests NuScale is 5-7 years ahead of the competition.

The Company already has one customer in the US and 19 MOUs globally - we expect to hear about new contracts with European countries in the near-term.

What is an SMR? It’s a nuclear power reactor that is smaller than traditional large scale nuclear reactors and modular. This brings numerous benefits:

1. It’s safer. If there’s any failure in each individual modular reactor, it automatically shuts down and can be “left alone” because of its relatively small size (<5% of traditional reactive material)

2. It’s cost competitive. The reactor towers will be manufactured in a facility and delivered to the site, enabling benefits of scale vs. “stick built” traditional nuclear plants

3. Flexibility enables more applications. Smaller scale means more “bite size” plants can be utilized globally; these plants can also be used for desalination of seawater or to produce hydrogen

The world has completely changed over the past six months in favor of SMRs. The European energy crisis and geopolitical threats (Russia in particular) have made the world realize that nuclear energy needs to be part of the clean energy transition, and SMRs are the key technology. There are numerous news articles and government studies (UK + Australia notably) to get further up to speed, but the below SPAC presentation is a good starting point.

NuScale SPAC Press Release

NuScale SPAC Presentation

Also noteworthy is the US government’s backing. The infrastructure bill includes funding for SMRs, and the Biden administration (led by U.S. Special Envoy for Climate John Kerry and Secretary of Energy Jennifer Granholm) helped negotiate a Romanian MOU at COP26.

Biden FactSheet with NuScale Callout

In terms of valuation, we all have our doubts about SPACs. We have admittedly spent 90% of our time in SPACs on shorts. But this one we actually believe the risk/reward is interesting from $10.

First, NuScale raised nearly $200mm YTD, most recently at a $1.6bn valuation - this was before the European energy crisis and a few additional MOUs (notably Romania), so a $1.9bn valuation is not shocking.

Second, each plant it builds should be ~$1bn of revenue to NuScale at a 20-25% gross margin (excluding additional high margin ancillary services). The SPAC projections have it ramping up to ~10 plants/year by 2040. That sounds like a lot, but underpinning this is Bloomberg New Energy Finance’s projections and assuming NuScale takes 5% market share in SMRs. Again, these numbers sound crazy because they’re so large, but that’s what the world needs.

The projections also have it ramping to >$3bn EBITDA by 2030. Needless to say, you don’t need to believe anywhere close to any of these numbers for the company to be interesting at a $1.9bn valuation. A green-tech energy transition technology business should also garner a high multiple.

The other thing that we, as value investors, love about this is that it should be FCF positive by 2024. NuScale starts receiving cash from customers >5 years before delivery. To get to FCF positive, it basically needs ONE additional contract. We think this could come in 1H22.

But whatever, let’s say you’re still a skeptic. Each $2 SPAC price = ~$1.78 to FLR. So, if you think it’s going to trade to $6 because every SPAC trades to $6, then there’s 13% less upside in each case.

Just for reference, FLR adjusts ~$90mm of NuScale losses out of EPS but includes it in EBITDA. When we first invested, sellsiders capitalized the ~$90mm EBITDA at a 5.5-6.5x EBITDA multiple. While a couple have updated, most have not and continue to capitalize $1.4bn (FLR’s 60% pro forma equity stake) at -$540mm.

Management’s targets:

As you can see from the below table, $2.50-2.90 does not imply some outlandish topline or margin assumptions. Management has just indicated they assume MSD EBIT margins and thus you can back into a topline assumption. If we take $2.90 at and assume a 5.0% EBIT margin, it implies $16.8bn of revenue vs. 2007-2019 avg. revenue of $20.5bn. This isn’t even mid-cycle! Management is also taking out $150mm of cost which is worth 60c alone. We are comfortable underwriting the high end of this range but present a variety of cases in our base case returns. In our “high” case, we get to $3.50 of EPS at ~$20bn of revenue (2007-2019 avg. revenue) and a 5% EBIT margin.

Backlog Churned / LNG Canada:

For context on how much of the backlog has churned since Boeckmann returned, FLR has generated $32bn of cumulative revenue vs. the 2Q19 backlog of $35bn. FLR now has only $1.3bn of backlog (of a $21bn total) in loss-making projects. Of the $1.3bn, ~$1bn is the Gordie Howe bridge project, from which FLR still hopes to get Covid-related relief. It expects to complete all loss making projects by the end of 2022.

But the focus is LNG Canada (“LNGC”). LNG Canada is FLR’s largest project in its backlog at an original cost of $8.4bn (FLR’s share of the ~$15bn award). There is just over $5bn remaining in the backlog.

Q: What is the concern?

A: It’s a large, fixed price contract that was awarded in 2018 under the prior management team. Due to Covid, the project was delayed.

Q: What happens with a delay due to Covid?

A: Fluor has exercised force majeure and change of law provisions in its contracts. Basically, FLR is getting paid more money by the customer (Shell and a few others jointly own LNGC), which the customer has already agreed to. FLR has only asked for claims through early 2021, and will continue to seek additional compensation as the project progresses. Thus far FLR has received every penny it’s asked for.

Q: What gives us some relative amount of comfort?

A:

1. The contract is worth $8.4bn, of which we think there’s a ~$2bn contingency (which would equate to double a “normal” megaproject contingency) and >$1bn of profit (IR will confirm they priced double digit margins), so ~$3bn to play with on a ~$5.4bn project

2. The delays are Covid related and thus should be paid for by Shell et al - in December 2019 (months after FLR did a comprehensive backlog review under new mgmt.), FLR said the project was still on track

3. Our checks suggest that the delays (which again are getting paid for by customer) are ~12 months and probably only amount to a few hundred million dollars

4. The Company has still not taken a charge on the project and has no plans to

Q: What’s the customer’s view on the project?

A: Shell CFO 10/28/21: “What I would say is that the project itself is going very well. I think we've reached 50% of completion. Very pleased with the performance outside of Canada in terms of the supply chain and within Canada, particularly during the pandemic. So really, really pleased with the overall progress that the project has made to date.”

Q: Does the world even need LNG?

A: We’d be surprised if anybody on VIC doesn’t know the answer to this question. Let’s just say that the European energy crisis has caused LNG to be in vogue - see the price chart below. We would not be surprised to see Shell green light additional trains (more capacity) for LNGC. We think this would be huge for the stock - it would validate that FLR isn’t going to end up underwater on these projects, or else why would it agree to a larger scope?

Downside / Attractive Skew:

OK so we’ve talked about LNG Canada which is clearly the risk, but what we like in FLR is the attractive up/down skew across a range of potential outcomes.

In the below, we sensitize core business earnings from $2.00-2.50 in the downside scenarios and strip out any earnings from LNG Canada, PLUS hit them with a $0.5-1.5bn one-time charge. We then also assume the NuScale SPAC trades at $6-10. In the “low” downside scenario, assuming $1.69 of EPS at a 10x multiple, a $1.5bn charge, and NuScale trading at $6 we arrive at a ~$14 price target or -43%. Comparing this punitive case vs. our “mid” base case (+88%) still yields an attractive 2:1 up/down.

Any way we cut the math, the returns look attractive.

End-market inflection:

The Company has been talking about record bidding activity, and it makes sense. Commodity / chemical / energy prices are at the highs, supply constraints need structural changes to supply chains with more onshoring, we are consuming significantly higher amounts of physical goods vs. pre pandemic, we just passed a monumental infrastructure bill. Take a look at FLR’s end-markets and tell us, what do we not need more of in this picture?

And timing wise, FLR has definitively seen a trough in its backlog. The Company had a $21bn backlog at the end of 3Q21, and just booked a $14bn cost-plus award (will hit backlog in either 4Q21 or 1Q22).

The Company is currently working on >200 study and FEED prospects for the next 18 months which represent >$150bn of total installed cost. Near-term, the Company has $45bn of prospects over the next 12 months for projects >$50mm and a long-tail beneath that. 91% of that $45bn is cost-plus work. NINETY-ONE PERCENT. We cannot stress how important this is. You want evidence the Company is almost through its turnaround? Look at what it’s bidding on and what that could do to its business mix going forward.

Catalyst

NuScale SPAC closing in 2Q22

Large new project awards in 1H22

Positive LNG Canada Updates