Introduction
KBR (KBR), a leading diversified Research, Engineering, and Consulting firm with an extensive history of advanced scientific innovation has continued to do so over the past quarter. A significant number of new projects have been announced, and I believe discussing them will highlight the potential of this company as an investment in the future. While I previously discussed how the past was also dark and an acute risk point, the company is quickly finding redemption in a move towards sustainability and science. The company got moved up in rating by Moody's, with the researchers highlighting reduced debt, risk, and positive outlook, even with the large Frazer-Nash acquisition.
While the company has multiple feelers spread out into high-growth ventures and speculative technologies, the investment in KBR is far from speculative as they receive revenues based on research rather than outcome. Not to mention various infrastructure applications across industrial software, public works, and even space endeavors all have 5-10 years at least of visibility for the company. This article will highlight the key contracts released over the past few months, then discuss any relevant financial updates to my original thesis.
Next-Gen Research and Solutions
I will start with one of the most promising innovations of the next decade or more, modern plastics recycling. KBR has licensing exclusivity of the Hydro-PRTSM recycling technology, and recently announced their first major contract with LG Chem (OTCPK:LGCLF) in Korea. This technology utilizes supercritical steam to convert single-use and other plastics back into the constituent raw components which can then be reused. This is the first circular recycling path for some forms of plastic, and will no doubt have a significant positive impact on the environment and prove profitable for plastics developers. The new contract will allow KBR to develop and engineer the platform at a chemical plant but is supposedly easily scalable and this instance will be an important showcase for future uptake.
Renewable Energy
While KBR has a past based almost entirely on supporting and modernizing the Oil & Gas industry, a shift towards renewable energy production has commenced. However, this is not your average solar or wind application, but instead, focuses on efficiency, green or blue energy sourcing, and biofuels. One project recently announced is a contract for the study of a joint collaboration between the forestry and energy production industries. In particular, Biojet AS, half-owned by Exxon (XOM), is contracting KBR to develop the necessary infrastructure to produce biofuels from waste forest products.
Moving on to hydrogen, the company has seen multiple new contracts to develop hydrogen production plants in the US and abroad. This segment may prove slow-moving due to competition against names like Plug Power (PLUG) or Bloom Energy (BE), but KBR is far more diverse in their personalized capabilities. One recent contract is for a new liquid hydrogen plant in Oklahoma, owned by Australian Woodside Energy (OTCPK:WOPEF), and net-zero in final operation (based on Oklahoma electricity grid sources).
Another is a government-sponsored study to determine hydrogen infrastructure possibilities on the islands of Trinidad and Tobago. The country has the goal of being the leading hydrogen producer in the region, and this early supply & demand, development, and implementation research by KBR will lay down the foundation for growth over the years to come.
While the financial positives of the hydrogen industry are heavily debated, it should be helpful to realize that KBR obtains these contract revenues regardless of the financial outcome of final operations. Further, they are able to produce and develop the latest technologies in the industry to optimize costs and reduce the overall impacts of these measures, much like their former work in the Oil & Gas industry.
The last great, but forgotten form of clean energy generation is nuclear, which is seeing a resurgence in some parts of Europe and the world. The recent acquisition of Frazer-Nash has allowed KBR to move back into modern nuclear energy research and development. FN has over 30 years of experience developing processes and systems in the industry, and is now looking towards more advanced technologies. One example is the production of Hydrogen using nuclear power as a way to produce green hydrogen. Another is the import future of fusion technology, with Frazer-Nash being a tier-1 supplier in a new manufacturing consortium in the UK. With new developments in safety and waste disposal, I hope to see a significant increase in this important energy production medium soon.
Green Fertilizer/Nitrogen-based Inorganics Production
While renewable energy generation is an important part of a clean and sustainable future, food production is also a key component that is often neglected. Of importance, is the production of fertilizers and other nitrogenous bases that are necessary for high yields on our ever increasingly valuable agricultural land. However, the production of these compounds was often quite inefficient and carbon-intensive, but KBR has a diverse suite of solutions to combat this issue. In particular, they offer one of the best-optimized ammonia production processes in the world, and these are in place at over 244 ammonia plants worldwide.
Moving beyond food production, ammonia has found a new calling as a form of clean energy storage medium. Remember from chemistry? Ammonia, formula NH3, decomposes to hydrogen and nitrogen gas. With that, three new use paths are available. According to a recent report with the Royal Society, here are the three paths:
While there are certainly risks to account for - I am sure no one needs reminding of what happened in Lebanon just a short while ago - KBR is working to develop the next-generation plants that harness ammonia's potential power. In particular, most plants with KBR operation and digital solutions now produce CO2-free ammonia, and new projects in Oman, Alberta, Canada, and Beaumont, Texas also incorporate methanol production alongside ammonia. This includes a partnership with Johnson Matthey (OTCPK:JMPLF) and their ammonia cracking and synthesis technologies (as a side-note JM also partners with Plug Power in hydrogen processes). One can also consider KBR as a software provider, as their digital solutions are one of the main components of increasing operational efficiency, and the requirements by governments in decreasing CO2 emissions will be an important catalyst in deployment growth over the next few years.
In regards to other nitrogenous materials, KBR recently announced a new contract for the PLINKE nitric acid recycling technology. This contract will allow KBR to design, engineer, and license a nitric acid production, treatment, and recycling facility in South Korea for Hanwha Solutions. Nitric acid has endpoints in polyurethane foam production and the semiconductor industry, and so, this will aid industrial companies in reducing some of their impacts. The KBR PLINKE technology suite also has usability in other industries including, chemicals and fine chemicals, fertilizers, pharmaceuticals and life sciences, metallurgical, petroleum refining, and other industries.
Defense Innovation and Cybersecurity
Government solutions are a major part of KBR's revenues, and multiple new important developments have occurred over the past few months. In particular, an indefinite delivery/indefinite quantity contract was awarded for an ASTRO contract from the General Services Administration for services and research relating to manned, unmanned, and optionally manned tactical and robotic systems and platforms. Other companies also involved in the ASTRO project include Raytheon (RTX) and Northrop Grumman (NOC), and their linked pages offer further insights into the program. With no budget limits, and at least a five-year contract length, this helps diversify KBR's government services and may provide significant growth.
Moving on to another key topic of the present day, semiconductors and microelectronics. Thanks to Moore's Law, small-scale computer chips and other sensitive components are in nearly every present day piece of manufacturing. Importantly, this creates an inheritance security risk as non-US based manufacturers are given significant trust not to provide "contaminated" products. As an example, most government computers or other tech components contain microelectronics that may be compromised and prevent the government from operating. According to Dr. Santanu Bag, a KBR research program manager:
To tackle this issue, KBR was awarded a $194.3 million task order to research, develop, test, and analyze the design and fabrication of microelectronics components, verifying and validating their trustworthiness for various government agencies. With applications in both digital and analog settings, there is also a team focused on cybersecurity-based vulnerabilities.
Under the task order, KBR performs multidisciplinary research and development of design best practices and methodologies for trusted systems in the digital and analog realms. While one can argue about the likelihood or impact of such interference by bad actors, one cannot deny the fact that KBR is a beneficiary of these preventative measures.
One group that depends on secure computer components is NASA, and KBR has a deep relationship with the agency. In fact, a recent milestone was accomplished for the deployment of new solar arrays on the International Space Station (ISS). As age has hindered the existing solar components, KBR trained, planned, choreographed, and troubleshot issues that arose during this years-in-the-making process. The pride of accomplishment could be seen over the three required spacewalks, and now the ISS has the majority of power generation based on these new arrays. This accomplishment is also significant in that the new arrays are serving as a test for the power generation and deployment capabilities of a moon-orbiting space station, the Artemis Gateway.
As a last note on the Government Services segment, KBR is leading a new joint venture called the HomeSafe Alliance, which is based on a potential $9 billion over 9 years contract with US Transport Command to provide logistical services to members of the Armed Services, DoD civilians, and their families. KBR will develop modern tech strategies to improve domestic and international relocation experiences and will focus on the movement of household goods. It is good to see that the government is spending on updating dated features, and KBR will see quite a hefty sum from this contract.
Infrastructure
KBR's presence internationally is often based on large-scale infrastructure projects, based on their historical expertise in a diverse range of heavy civil engineering applications. One important area of future-focused contracts of late is for Water Infrastructure in drought-prone regions, particularly Australian. In fact, a newly developed Water Solutions team is made to develop full-cycle solutions to municipalities and industries in order to ensure long-term water safety. Projects that are currently in the works include the Coalstoun Lakes and Hughenden Irrigation Developments.
Moving to traditional infrastructure, KBR has been busy developing various light rail network upgrades in the greater Melbourne area, including delivering the first 5 Star Green Star As Built Rating train station at Reservoir. Also, an $844 million package to redevelop the Pakenham level crossing will incorporate green space and well-optimized infrastructure routing in a suburban setting. The joint venture, North West Program Alliance, is set to be a leading engineering conglomerate in the region over the next decade or more and will provide a steady stream of revenues for KBR.
Further, KBR has road-transportation projects in the works in other regions of Australia via the Transport for New South Wales (TfNSW) Comprehensive Technical Services Panel (CTSP). With services relating to geotechnical, environmental, and design processes, long-duration contracts will continue into the future through multiple KBR subsidiaries. It is not just Australia either, thanks to a new 4-year $126.7 million contract from the U.S. Department of Transportation (DOT) Volpe National Transportation Systems Center for Mission Information Technology Support (MITS) Services in Cambridge, Massachusetts that is based on modernizing technical, logistical, and safety-related transportation systems.
While risk is limited due to KBR's storied history and numerous recent case studies that exhibit their capabilities, one must consider that their new sustainable project paths are not proven yet. Further, there is plenty of competition in the infrastructure and clean energy segments, and this will likely inhibit growth long-term. The positive paths for KBR seem to be relating to broad Government Solutions contracts that are already based on years of practical relationships with various agencies. The company will always have these to fall back on, but future growth is quite dependent on the new opportunities I have discussed.
Growth Trends
Q3 was a healthy report, but with the company shifting the revenue structure around it is hard to determine growth patterns. While overall revenues are up over 30% YoY, the renewable segment is down YoY. In the short-term, watch overall revenues and earnings growth, but within a few years, we should see how the Sustainability segment begins to be the main contributor to growth. As we can see in the results, the GS segment saw tremendous growth, in part to recent acquisitions, but with a strong 33% organic opportunity. Significant new contracts in the Defense & Intel and Readiness & Sustainment groups are the main reason for this increase in revenues. This is a good sight as in prior years the GS segment was far slower moving.
Unfortunately, GS EBITDA is not increasing in line with revenues, but this is typical with contracting. Each project is different, and governments tend to be stingy. Although, the rise of digital services in the STS segment will drive EBITDA upwards favorably, and management seems to be happy with the recent results. As this is a slow-moving company, single quarters are hardly of worry, but I will be watching the longer-term trends.
One favorable financial indication that has been improved, however, is debt and liquidity, and the company has recently been upgraded overall by Moody's. With a current net leverage of 1.9x compared to a goal of <3.0, the company is already in a stable place. With this, the company also had enough capital to buy back $25 million worth of shares and increased the dividend by 10% YoY. Low-risk investors looking for exposure to sustainable development without the negative risks from negative cash flows or speculation should be quite happy with an investment in KBR.
Favorable Guidance Increases
2021 is set to beat expectations by a significant margin thanks to contracts based on Operation Allies Welcome, the operation to resettle those withdrawn or seeking refuge from Afghanistan. A boost in revenues of $1.4 billion is significant, but only low single-digit EBITDA is expected. However, this, along with other operational synergies, has allowed management to increase high-end EPS guidance by 50%. Since the large OAW revenues are low margin, it is good to see EPS still remains increasing. However, this is a one-time opportunity for KBR, and I expect 2022 will cool off slightly in regards to large contracts such as this. Conflict within the public sector is leading to a slowdown in funding, and the BBB bill has yet to be approved. Further, impacts from the major infrastructure bill are yet to be seen, and many engineering and infrastructure companies seem to be hanging by a thread awaiting revenue supplementation.
Valuation Expansion Occurred but Has Already Reset
As a result of the general market volatility, failure to pass the BBB bill, and uncertainty over infrastructure spending, KBR has seen a decline in price over the past few weeks. Down 11% from all-time highs, the stock is now at a similar share price and valuation to my prior article in spring 2021. Due to the far more stable financial foundation, a return to growth, and potentially favorable fiscal environment over the next few years, I find that the current valuation is fair to even undervalued. As such, I expect this to be a solid time to start a position or add to your holdings. Just don't expect huge gains over the short-term, but do look for stability compared to the overall market.
Conclusion
As you can see, there are many reasons to invest in KBR, whether the cool next-generation research and design you are investing in, or the ever-improving financial position. When combined with a low valuation at industry-leading performance, I remain quite bullish on the company. Taking this into consideration I will set a price target range of $55-60 and expect the company to reach this point over the next 1-2 years if the market lets it. However, investors will still need to see margins improve to a higher level, and remain net-income positive across GAAP and non-GAAP measures before any meaningful increase in valuation can be held. Although, one can say that the outlook is far greater now than over the past decades as controversies mired the company. With those issues now in the past, consequences from those actions may still be an issue, but every passing year dissipates the risk.
Time will tell. Thanks for reading, and feel free to comment anything below.
