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Who'll profit from rebuilding Iraq?
Billions will be poured into roads, bridges, schools, hospitals and oil fields, but picking which companies will benefit isn't all that easy. Here are caveats for investors, plus some stocks with promise.
By Michael Brush
Sadly, no one can ever bring back the lives of soldiers and civilians lost in the ongoing war in Iraq. Once the conflict is over, however, efforts will begin to restore the country and its economy.
While those days still lie far ahead, many investors are already quietly pondering the reconstruction phase, wondering what companies might benefit from a Marshall Plan of sorts for the country.
After all, big sums are in play.
Exactly how much is still anyones guess.
But the United Nations Development Program thinks the cost of rebuilding everything from oil fields and roads, to hospitals, schools and airports, will top $30 billion in the first three years.
Assessing the pitfalls
Figuring out exactly which companies may win and lose isnt too difficult, but it is fraught with potential pitfalls. Heres a look at some myths that can get investors in trouble if they arent careful.
Myth # 1: You should buy oil-field service companies.
So far, Iraqi oil wells have made it through the conflict relatively unscathed. Out of a thousand wells in the south, a region that accounts for about two-thirds of Iraqi oil production, only about 10 were lit on fire.
Even though the oil fields werent blown up, theyve been abused and need repair, so oil-field service and drilling companies will still have plenty to do in the country after the war. That's seductive reasoning for many money managers.
There is going to be a lot of work there because the infrastructure is not in great shape, says Waqar Syed, who worked in Iraq with oil-field services company Schlumberger (SLB, news, msgs) during the early 1990s. Syed now analyzes stocks in the group for Petrie Parkman, an energy-related investment bank in Denver.
Iraqi oil-field workers, for example, used a common technique of injecting water into underground structures containing crude. This normally makes it flow better. The problem is, instead of using filtered water, they took water straight out of the Euphrates River, and clay in the water has gummed up the works in the wells. Beyond that, much of the equipment has been poorly maintained.
Initially it would be well redemption work, says Syed. He thinks Schlumberger stands a good chance of picking up a lot of this work because it has a long track record with the Iraqi national oil companies.
Contracts are already starting to come out of the government. Kellogg Brown & Root, a subsidiary of Halliburton (HAL, news, msgs), in fact, was awarded a contract late Monday to repair oil-field damage. Halliburton said it was too early to put a value on the contract. Another oil-service giant expected to do work in the region is Baker Hughes (BHI, news, msgs). Both Halliburton and Baker Hughes have large presences in the Middle East.
Next, only about 15 of the countrys 70 or so oil fields are in production. That leaves room for drillers and oil field service companies to step in to develop more fields if a new Iraqi government decides to increase production to help generate the funds to get the country back on its feet.
This suggests drilling companies with large presences in neighboring countries -- such as Global Santa Fe (GSF, news, msgs) and Nabors (NBR, news, msgs) -- may be called in after the initial repair work, says Syed. A Dutch company called Core Laboratories (CLB, news, msgs) could benefit as well. The company is already in Iraq mapping out reserves on behalf of the U.N., says Jason Selch, an oil-sector analyst with Liberty Wanger Asset Management.
It's tempting to believe this bonanza of profitable work makes these companies a buy right now, but don't be fooled. Oil prices are likely to decline sharply after a conflict, and that could hurt business overall. (Light sweet crude, the benchmark U.S. crude, fell 69 cents a barrel to $27.97 on Tuesday.)
When oil prices decline, oil-field services companies do less business because their customers -- the oil companies -- have fewer dollars to spend on upgrading equipment and exploiting new oil fields.
After the conflict in Iraq is over, oil should slip to the low $20 range, predict energy analysts at Prudential Securities, because world oil supply and demand are little different compared with over a year ago when oil was $19 a barrel. Thats one reason Prudentials Grant Borbridge downgraded the oil-field services group last week.
If oil stays under $25 -- and some grades briefly slipped under that level last week -- these companies would be a risky bet.
Myth # 2: You should short foreign companies doing business in Iraq if they come from countries like France, which strongly opposed the invasion.
Cynics like to point out that the three main foreign oil companies working in Iraq all hail from countries that were the more-vocal opponents of the U.S. and British invasion of Iraq -- France, Russia and China. Once the conflict is behind us, will it be payback time for Frances TotalFinaElf (TOT, news, msgs), Russias Lukoil and the China National Petroleum Corp.?
And what about Alcatel (ALA, news, msgs), which installs gear for the Iraqi phone system? Or Peugeot (FR:12150, news, msgs) and Renault (FR:13190, news, msgs) and the electrical equipment maker Schneider Electric (FR:12197, news, msgs), all French companies doing business in Iraq? Might these companies be good shorts because France was so opposed the invasion?
Probably not.
First, for public-relations reasons, the United States is unlikely to be so spiteful as to push these companies out. I think the Americans will be a little reluctant to go rushing in because of the concern that we not be perceived to have fought the war over oil, says John Connor Jr., portfolio manager of the Third Millennium Russia Fund (TMRFX). Besides, says Connor, foreign companies doing business in Iraq have an expertise that will be needed in any reconstruction effort.
Whats more, the United States is going to want other countries to help in rebuilding Iraq -- both because of mounting deficit problems at home, and because it wants to defray criticism the United States has a secret agenda to colonize Iraq. European governments, however, arent likely to kick in development money only to see their companies get cut out of business opportunities in Iraq.
Besides, some of these companies dont do that much business in Iraq anyway, says Jean-Marie Eveillard, a portfolio manager at First Eagle Funds. For TotalFinaElf, it would be a loss of potential business, but not a loss of real business, he says. Eveillard is manager of three First Eagle funds: First Eagle Gold (SGGDX), First Eagle Overseas (FESOX) and First Eagle U.S. Value (FEVCX).
True, initial contracts for about $900 million worth of reconstruction projects will be limited to U.S. companies. But the U.S. administration says it wants to include contractors from other countries, once reconstruction gets under way in earnest.
Myth # 3: There won't be too much damage to infrastructure during the war, so any reconstruction effort will be smaller than expected.
War protesters had their hearts in the right place, worrying that Iraq would get bombed into near oblivion during the conflict. All along, however, military planners said they werent interested in taking out lots of the infrastructure, like bridges and highways. So far, they have kept their promise.
Nevertheless, much of the Iraqi infrastructure is in ill repair after years of neglect. Any Iraqi Marshall Plan will call for an upgrade of the creaky infrastructure.
This means the primary beneficiaries will include companies that specialize in developing things like schools, hospitals, power plants, dams, oil fields, airports and seaports, says Ted Parrish, co-manager of the Henssler Equity Fund (HEQFX).
Which companies will get the work?
The State Department, the Pentagon and the U.S. Agency for International Development, which provides economic and humanitarian assistance around the world, probably have a good idea already. Unfortunately, the agencies arent saying. But its not too hard to narrow down the list of dozens of construction engineering companies to a couple of likely winners.
Just look for companies that have done a lot of overseas work for the U.S. government and made significant political campaign contributions recently.
Many of the companies on this short list are private companies such as Bechtel, Parsons Corp. and Louis Berger Group. Two public companies likely to play a role include Fluor (FLR, news, msgs) and Washington Group (WGII, news, msgs), the former Morrison Knudsen.
Fluor tops the list because it is one of the world's largest engineering and construction companies, and it does plenty of business overseas and for the U.S. government. The company has experience building refineries, power plants, transportation systems and manufacturing and pharmaceutical plants. Fluor gets about 40% of its revenue from projects abroad.
Beyond any work in Iraq, as a construction company, Fluor will get a push if U.S. policies to stimulate the economy actually kick in. Meanwhile, Fluor has a strong balance sheet and looks relatively cheap.
If you subtract the $4.25 per share in cash thats not already earmarked for expenses, its trading at just under 11 times 2003 earnings of around $2.30, the low end of its historic valuation range.
Theres a chance it could sink even lower if the economy falters. Investors should be aware of other potential problems. There are a lot of risks to construction projects, like estimating costs correctly, says Parrish. And companies dont get a big pop in cash until a project is done because they are paid as projects are finished.
Washington Group, based in Boise, Idaho, has lots of experience working for the U.S. government and overseas, as well. It gets about 30% to 40% of its revenue from projects outside of the U.S. -- including plenty of work in the Middle East putting up bridges, roads, dams, power plants and desalination plants. As Morrison Knudsen, the company built the King Khalid Military City in Saudi Arabia in the 1970s. The company also builds manufacturing plants, pipelines and railroads.
Two other qualities, however, make it look like a good candidate to win contracts for work in Iraq. First, its the biggest engineering and construction subcontractor serving the Department of Defense. Second, its the dominant player in chemical weapons destruction, and it has extensive experience handling nuclear material. We are the leader in the chemical weapons destruction business and we are the biggest handler of plutonium in the world, says Washington Group spokesman Jack Herrmann.
So if it turns out Saddam Hussein really was developing chemical weapons and material for nuclear weapons, Washington Group is likely to get the call to help with the cleanup.
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