Oil and natural gas exploration and production equipment maker Dresser-Rand Group (NYSE:DRC) popped 13.6% yesterday after announcing it would buy $150 million worth of its stock, or about 5%, while issuing bullish guidance. Is this a one-day fluke, or is it a buy signal?
Dresser-Rand has not exactly been on a roll lately. After all, its second-quarter 2011 earnings were down and way below expectations. For example, its $10.7 million in net income was 69% below 2010’s second quarter, and its EPS of 14 cents per share was a whopping 31 cents less than the average of 13 analysts polled by Thomson Reuters.
The good news for Dresser-Rand was its total revenues for the quarter of $514.1 million were 19.2% higher than in 2010 but roughly $30 million below expectations. The increase was due to higher volumes reflecting the recovery in global energy infrastructure markets.
With all the flopping around in Dresser-Rand’s numbers, should an investor buy or sell its stock? Here are two reasons to consider buying it:
- Cheap stock. Dresser-Rand’s price/earnings-to-growth ratio of 0.56 (where a PEG of 1.0 is considered fairly priced) means its stock price is cheap. It currently has a P/E of 34.4, and its earnings per share are expected to grow 61% to $3.19 in 2012.
- Increasing sales and profits and cash-rich balance sheet. Dresser-Rand has been increasing sales and profits. Its revenue has grown at a 7.5% annual rate, from $1.5 billion (2006) to $2 billion (2010), while its net income has increased at a 16.4% annual rate, from $79 million (2006) to $145 million (2010) — yielding a 7% net profit margin. It has $370 million in long-term debt, and its cash rose at an annual rate of 30%, from $147 million (2006) to $421 million (2010).
Two reasons to hesitate:
- Inconsistent earnings reports. Dresser-Rand has beat analysts’ expectations inconsistently — it has overachieved in three of its past five earnings reports. But in the quarter ending June 2011, Dresser-Rand missed estimates by 70%. This big miss puts its credibility on thin ice.
- Under-earning its cost of capital and doing worse. Dresser-Rand is earning less than its cost of capital — and it’s getting worse. How so? It’s producing negative EVA momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In 2010, Dresser-Rand’s EVA momentum was -8%, based on six months’ annualized 2010 revenue of $1.9 billion, and EVA that fell from six months’ annualized 2010 -$26 million to six months’ annualized 2011 -$179 million, using an 11% weighted average cost of capital.
If you believe management’s bullish forecast, consider buying now. If you’re skeptical, take a fresh look after the company reports third-quarter results.
Peter Cohan has no financial interest in the securities mentioned.