Investors who earned big returns in the wake of Hurricane Katrina may want to reassess their storm-related plays now that new contracts for repair work on the U.S. Gulf Coast have slowed.
Shares of construction and engineering companies, oil services providers and their suppliers surged in the past year on the prospects of millions of dollars in contracts to repair infrastructure.
But sustaining returns at post-Katrina levels looks increasingly difficult for contractors such as McDermott International Inc. and Fluor Corp., which are among those that benefited most from the rebuilding effort.
After gains in the range of 25 to 80 percent, valuations of such stocks are now well above their benchmarks as well as historic averages. At the same time, business from some of the biggest sources of reconstruction money, including the Federal Emergency Management Agency, is dwindling.
You run the prices up to ridiculous levels and then people realize that - wait a minute - you cannot extrapolate this need into the future, said Malcolm Polley, chief investment officer at S&T Wealth Management in Indiana, Pennsylvania.
For construction and engineering shares in particular, Polley said he would sell them now and buy them back after a 10-15 percent drop.
Shares of McDermott, an oil and gas services company that specializes in offshore construction, have risen 81 percent in the last 11 months to $43.77. That compares with a 10 percent rise in the S&P Energy index and a 8 percent increase in the Philadelphia Oil Service Index.
From a valuation perspective, McDermott's prospective price-to-earnings ratio nearly doubled to 22.4 earlier this month from 12.5 times just before Katrina hit. McDermott shares have pulled back sharply this month with the drop in oil prices and now sport a PE of about 18.6, still well above average.
McDermott's valuation gains make it pricey relative to the broader oil services group. The Philadelphia Oil Services index now trades at about 9.3 times estimated 2006 earnings.
Longer term, the construction, especially the topside and marine construction that McDermott does, is a good story. But short-term I expect the stock to continue coming down, said Sarah Hunt, an analyst with Capital Management Associates in New York, calling it expensive.
Hunt sees services companies such as McDermott benefiting from production related to a large Gulf oil discovery made by Chevron Corp. and its partners, but not in the near term.
Beyond that, falling commodity prices are a bigger factor for the energy services industry right now, Hunt said, and oil's steep decline will pull the whole sector down.
Fluor, the Texas-based engineering and construction company, shot up 5.7 percent on August 31, 2005, as investors bet the contractor would be a strong Katrina play. Its shares are up 26 percent over the last 11 months and now trade at $79.80.
Fluor's PE ratio rose from 25 at the end of August 2005 to 31 this week. By comparison, the S&P 500 prospective PE ratio is about 14.8.
Fluor said after its second-quarter earnings that contributions from (Katrina) work would decline significantly during second half of 2006, said Stewart Scharf, a Standard & Poor's equity analyst.
In fact, FEMA Director David Paulison told Reuters in an interview on Wednesday that much of the money it sent to states hit by Katrina has already been committed.
Even though Scharf expects Fluor to replace much of that revenue with new business, he has a hold on the shares in light of its high multiple, project cost overruns and less work coming in from Katrina and rebuilding in Iraq.
Shaw Group, a Louisiana-based engineering and construction company that become the hometown favorite of the companies expected to benefit from the rebuilding, rose sharply in the days after Katrina hit. But Shaw did less FEMA work than had been expected, Scharf said.
Its shares nearly doubled from $17 before the storm to $36 in February, before tumbling in the following months on news of accounting errors and disappointing earnings.
Companies that make mobile homes and manufactured housing also surged in the wake of Katrina as residents fled New Orleans and other Gulf Coast cities in search of new shelter. But the jump in demand is considered a one-time event.
Thor Industries Inc. saw big initial demand for trailers to house people after the hurricanes, (but) that will not follow through this year unless you have more hurricanes, S&T's Polley said.
Thor shares are up 31 percent in the last 11 months and now trade at $42.80. By comparison, the Dow Jones U.S. Recreational Products Index has fallen about 12 percent.
(Additional reporting by Daniel Trotta)