KBR's history, business operations, and international expansion

KBR

Company Profile

KBR (Kellogg, Brown and Root) has its origins in a 1901 pipe fabrication business. By 1927 the company was becoming engaged in the petrochemical processing industry, in which it remains active today. The company also had a shipbuilding business, which contributed to its activities in offshore oil drilling. The company was purchased by Dresser, which was then purchased by Halliburton. In 2007, KBR was spun off from Halliburton and continues today as an independent entity. KBR employs over 40,000 people. The company is engaged in engineering, construction and services, focused largely on the oil industry and defense. The company has also recently become engaged in the power, chemicals, petrochemicals and health care industries (KBR.com, 2011, History).

KBR has ten business units: Downstream, Gas Monetization, Infrastructure and Minerals, International Government and Defense, North American Government and Defense, Oil & Gas, Power & Industrial, Technology and Ventures. The company is heavily involved in oil and gas in particular and claims to have built "over half of the world's liquefied natural gas production capacity over the past 35 years, and the first offshore platform beyond the sight of land" (KBR.com, Company Profile). The company's mission statement is "To safely deliver any project, any time, in any environment for the benefit of our customers, shareholders, employees and communities we serve" (KBR.com, Mission, Vision and Values).

In terms of size, KBR recorded revenue of $12.06 billion in 2009, up from $11.493 billion in 2008. Net income for 2009 was $290 million, down from $319 million in 2008 (MSN Moneycentral, Financial Results). The company's stock currently trades at $35.06, just below the 52-week high. The company pays a dividend of $0.20 per year, for a dividend yield of just 0.57%. The earnings per share in 2009 were $2.02. The beta is 1.12 (MSN Moneycentral, Quote).

The income statement shows a sharp increase in the company's revenues in 2008, attributable to its purchase that year of privately-held BE&K. This deal added 9000 employees to the company. BE&K is focused on the engineering, construction and maintenance industries (Cooper, 2008). This acquisition helped the company to a 40% increase in profit in Q2 of 2009. KBR has also benefited from multiple government contracts. It provides non-military services such as food, laundry, fuel and lodging to U.S. military operations in Afghanistan, Iraq and Kuwait. In its other business, KBR is active in natural gas in Nigeria and Australia, has an offshore project in the Caspian Sea and has UK military contracts similar to its American ones (Clanton, 2009).

International Arena

One of KBR's first international operations was the construction of Europe's first crude oil-based liquid ethylene cracking facility in 1956 (KBR.com, History). The company became active in the North Sea in 1965 (Ibid) and has been in the international arena ever since. The company today operates in a number of international markets. In addition to U.S. And UK military work in the Middle East and Central Asia, the firm is involved around the world in oil and natural gas. This includes the aforementioned Nigeria, Australia and Caspian operations, along with Saudi Arabia (KBR.com, Petrochemicals), Egypt (KBR.com, Syngas & Fertilizers), Qatar and Bahrain (KBR.com, Transportation), Ireland (KBR.com, Investment and Asset Management) and others.

At this point, KBR has operated nearly 60 years in Africa, maintaining the regional headquarters in Johannesburg (KBR.com, Africa). It has offices in both Mexico and Canada, and is involved in the oil industries in both countries (KBR.com, Americas). It has offices in Indonesia, Singapore, India and China and has its biggest project there in Indonesia's Papua province (KBR.com, Asia). European offices are in Moscow, Goteborg and the UK and the company remains heavily involved in the North Sea, the UK Department of Defense and the Caspian (KBR.com, Europe).

International Issues & Challenges

There are few corporate records for KBR's international activities dating to the 1950s and 60s when the company first went international. At the time, the greatest challenges in its work most likely related to the technical challenges presented by the tasks -- such as building the first liquid natural gas extraction sites and the early offshore oil platforms. The company has long had close connections with the U.S. And UK governments, which at the time were seeking to control much of the global oil trade, and much of its early work overseas was conducted with the support of these governments.

In more recent years, the company has faced difficulties with respect to its offshore financial operations. The company has made use of shell companies registered in the Cayman Islands to employee nearly one-third of its workforce. This helped the company skirt U.S. taxes, Social Security and Medicare contributions. This led to a scandal in 2008 and questions regarding the firm's ethical standards (Stockman, 2008). Taxation has become the biggest international financial issue for the company.

Operating in volatile regions would imply that security should be an issue for KBR. In particular, the company's operations face significant political risk, in addition to risks associated with terrorism and crime in the Middle East and Africa particularly. KBR largely offsets these risks two ways. The first is that KBR is a major security provider, so is able to protect its own interests from terrorism and crime (Halliburton.com, 2005, Defense). In addition, the company's close ties to the U.S. government in particular have allowed it to operate in war-torn countries with the safety and protection of the U.S. military. Security of foreign workers, however, remains an issue for the company. At least 110 of KBR's employees have been killed in Iraq since 2003 (Lozano, 2008). The company's track record of safety in other volatile regions and with subcontractors does not appear to differ from is track record in Iraq.

The company also has faced issues with internal discipline. Highlights of its track record in managing employee conduct include the electrocution of soldiers in Iraq (Risen, 2008), a situation that led to significant conflict with the U.S. Army; and a gang-rape case where KBR covered up evidence (McGreal, 2009); accusations of human trafficking among KBR employees (AFP, 2008). These challenges relate to the difficulties that a firm has in ensuring an appropriate corporate culture in relatively lawless places. That KBR has struggled so widely on fundamental ethics in its overseas operations is an indicator that operating in extreme conditions remains a challenge for the company.

Volatility, Exchange Rates, Hedging Activities and Property Rights

The company has a large number of fixed price contracts, which increases the firm's exchange rate risk. Approximately 18% of the firm's contracts are fixed-price, versus 82% cost-reimbursable (2009 Annual Report, 25). The latter are less risky, since costs associated with exchange rate fluctuations are passed onto the customer. However, with fixed-price contracts, KBR is subject to foreign exchange risk to the extent that there is a difference in the currency of the transactions involved in bringing that contract to fruition. Revenues from these contracts are subject to translation risk even if the transaction risk is hedged. In addition, the company has approximately $14 billion in revenues in its backlog. To the extent that these represent fixed-rate contracts or foreign currency contracts or costs, KBR is subject to significant exchange rate risk should exchange rates fluctuate significantly between the time of contract signing and the time of performance (2009 Annual Report, 27).

The most significant hedge for KBR is the use of U.S. dollars in its contracts. The company prefers to use U.S. dollars as a means of mitigating exchange rate risk. In addition, it pays most of its employees in U.S. dollars and deals in dollars with most of its suppliers. That said, there remains "a sizeable portion of our consolidated revenue and consolidated operating expenses…in foreign currencies." This raises two specific forms of risk -- transaction and translation from exchange rate fluctuations and the risks associated with moving money between jurisdictions for re-investment. The company specifically notes that there are "limitations on our ability to reinvest earnings from operations in one country to fund the capital needs of our operations in other countries" (2009 Annual Report, 32).

The company is compelled leave some of its foreign exchange exposure unhedged, because some of this exposure derives from operations in nations that do not have hard currencies. Often, local governments in these nations insist that the contracts are denominated in local currency, which limits the hedging options for KBR, as soft currencies are relatively illiquid and do not have active derivatives markets (Ibid). Where possible, KBR does use derivatives to hedge foreign currency exposure, but this is typically with respect to major currencies for its Canadian, British and Australian businesses. Middle Eastern and African business often results in exchange rate risk that is much more difficult to hedge (Ibid).

KBR also faces risks with respect to property rights. The company makes extensive use of intellectual property, but by the nature of its operations often uses this technology in nations that do not have Western-quality intellectual property rights laws. There are also risks associated with licensing property rights from third parties, as those license rights may expire or be withdrawn (2009 Annual Report, 28). There is no discussion of physical property rights in the annual report, and no insight is provided into physical property rights in a search of online resources either.

Outlook

KBR's stock is presently trading near its 52-week high. The company was spun off at $21 and jumped on debut day to $24.77. This was following expectations of an IPO in the $17 range (Kirdahy, 2006). The stock rose to nearly $40 by November of 2007, but fell since that point. The stock has generally been on the rise since early 2009, more than doubling in that time (MSN Moneycentral, KBR).

KBR generally has good financial metrics. The current ratio is currently 1.59, compared with 1.36 in 2008 and 1.54 in 2007. The quick ratio is 1.24 compared with 1.08 in 2008 and 1.37 in 2007. The cash ratio is 0.41 compared with 0.37 in 2008 and 0.71 in 2007. These figures are all healthy and for the most part represent improvement over the past couple of years in the company's liquidity. With respect to long-term solvency, KBR carries a debt ratio of 0.57 for 2009, 0.65 in 2008 and 0.56 in 2007. The company has generally reduced its reliance on debt financing over the past five years. KBR holds no long-term debt and has not had any on the balance sheet since 2005. The firm's equity level, however, is stuck at 2007 levels. This indicates that the company is essentially in a holding pattern. That it was able to acquire a large competitor without adding long-term debt is perhaps the best indicator of this company's long-term financial health.

KBR operates on tight margins. The firm's gross margin in 2009 was 5.9%, compared with 5.8% in 2008 and 4.8% in 2007. Despite this, low levels of overhead have allowed KBR to remain profitable. The net margin in 2009 was 2.4%, compared with 2.8% in 2008 and 3.5% in 2007. These figures indicate that there has been a slight decline in the company's net margin despite improvements in the gross margin. Selling, general and administrative expenses have declined, but income taxes have increased. It is worth noting that the increase in income tax provisions coincides with the company's income tax evasion scandal.

In terms of operating efficiency, KBR recorded a receivables turnover of 6.0 in 2009, compared with 5.9 in 2008 and 4.8 in 2007. Asset turnover was 2.1 times in 2009, 2.1 times in 2008 and 1.6 times in 2007. This indicates that the company is making more efficient use of its assets in recent years. There is no inventory on its balance sheet, so no inventory turn could be calculated. The company's return on equity is 14.0%, its return on assets is 7.0% and its return on invested capital is 12.5%. These figures are part of a general trend of improvements over the past ten years (MSN Moneycentral, Key Ratios). In that time, the company has generally improved its book value per share, and has seen significant fluctuations in its price/earnings ratio. At present, the P/E is 17.56, which is higher than the 2009 average.

Overall, KBR believes that it will face challenges in the next few years associated primarily with the winding down of U.S. military operations in Iraq and Afghanistan. This will reduce the number and size of contract opportunities in these countries, and consequently the revenues that KBR can earn from these operations (2009 Annual Report, 1). The company believes, however, that it has other revenue streams in place that can help to offset the loss of Afghanistan and Iraq revenues.

The economic and political climates are poor. Cuts in defense spending are imminent, which could impact on revenues for the company. In addition, economic growth is likely to be stifled on the basis of current economic strategies. Tax breaks for billionaires and cuts to other areas of the federal budget do nothing to help KBR, which relies on federal government contracts for a significant portion of its business. Given that similar cuts have already been enacted by another key customer -- the United Kingdom -- KBR is facing threats to two of its most important revenue streams. The ability of the company to continue growing in the future rests almost entirely on its ability to leverage the new opportunities that management believes the company has in Australia, Nigeria and Canada among others.

The company also faces challenges with respect to its ongoing ethics issues. While it continues to receive contracts from the U.S. military, it has also lost contracts recently as well. In general, the company was able to win no-bid contracts during the Bush administration, but that is not the case under the Obama Administration. Competition for Department of Defense contracts is now tough, which will continue to eat into KBR's revenue streams. That said, the company has a strong financial position. It has a new low-interest revolving credit facility that will keep it from taking on long-term debt for another three years. This gives KBR considerable financial strength going forward, in particular to reinvest in other growing areas of business. While the company may be spreading itself thin by having so many businesses, this becoming a problem is purely hypothetical at this point. Overall, it is expected that KBR will continue with its current path of moderate success, but without any increase in dividends the upside of its stock price may be tapped already. The current P/E is relatively high for a firm with uncertain future revenue growth. That the company has tight margins makes it all the more difficult to determine where it can improve profits, since cost cutting is not likely going to yield much opportunity. However, given the high level of experience that KBR has internationally, including in some very difficult countries, the company can find growth anywhere in the world in which it might exist, which is encouraging.

Appendix a: Stock Chart for KBR since IPO (Yahoo Finance)

Appendix B: Financial Statements for KBR (MSN Moneycentral)

Annual

Interim

2009

2008

2007

Period End Date

12/31/2009

12/31/2008

12/31/2007

Period Length

12 Months

12 Months

12 Months

Stmt Source

10-K

10-K

10-K

Stmt Source Date

02/25/2010

02/25/2009

02/25/2010

Stmt Update Type

Updated

Updated

Reclassified

Revenue

12,060.0

11,493.0

8,642.0

Other Revenue, Total

45.0

88.0

Total Revenue

12,105.0

11,581.0

8,745.0

Cost of Revenue, Total

11,348.0

10,820.0

8,225.0

Gross Profit

Selling/General/Administrative Expenses, Total

Research & Development

0.0

0.0

0.0

Depreciation/Amortization

0.0

0.0

0.0

Interest Expense (Income), Net Operating

0.0

0.0

0.0

Unusual Expense (Income)

4.0

-3.0

0.0

Other Operating Expenses, Total

0.0

0.0

0.0

Operating Income

Interest Income (Expense), Net Non-Operating

-1.0

35.0

62.0

Gain (Loss) on Sale of Assets

0.0

0.0

0.0

Other, Net

-3.0

0.0

1.0

Income Before Tax

Income Tax - Total

Income After Tax

Minority Interest

-74.0

-48.0

-34.0

Equity in Affiliates

0.0

0.0

0.0

U.S. GAAP Adjustment

0.0

0.0

0.0

Net Income Before Extra. Items 290.0

Total Extraordinary Items

0.0

11.0

0.0

11.0

55.0

Net Income

Balance sheet not available in table format, but can be found here: http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?lstStatement=Balance&Symbol=U.S.%3aKBR&stmtView=Ann

Statement of Cash Flows not available in table format but can be found here:

http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?lstStatement=CashFlow&Symbol=U.S.%3aKBR&stmtView=Ann

Works Cited: