Bull/Bear Report: Build a Bridge to Chicago Bridge and Iron (CBI)

They say what comes around goes around. Enjoying the fruits of an unprecedented global economic boom that resulted in historical rises in oil prices, Chicago Bridge and Iron (CBI) saw its business grow substantially over the last few years.

Highly leveraged to the oil and gas industry (despite the name, CBI is not a bridge builder), CBI is a global engineering and construction firm that builds refineries, liquefied gas terminals, and pipelines. The company is involved in some of the biggest projects in the industry around the world.

Coinciding with the rise in oil prices, shares of the publicly traded company tripled in value or more since 2003. A strong backlog of projects with no end in sight gave investors comfort that cash flow and profits at would be steady and strong for the foreseeable future.

Ah, but wait a minute. These are huge construction projects that we are dealing with here that require tons and tons of raw materials and labor costs. What happens to the profitability of these projects when inflation hits?

Continue reading to find out...

Profits can drop like a rock and that is what happened to CBI recently. Indeed it is all well and good when oil prices go up, but the resulting inflation takes a big bite out of the supposedly rosy future.

In the middle of July, CBI jolted investors with an earnings pre-announcement that was specifically related to charges due to higher costs. Two major Liquefied Natural Gas projects in the United Kingdom were hit with weather delays and increasing labor costs.

The hit was $317 million or $2.38 per share. Ouch.

Shares of CBI fell hard on the news, but have recovered nicely as the rest of the market has rallied on the fall in oil prices.

The turned to our InvestorPlaceBlogs community, hosts of the just concluded Strategy Lab Open (please note that while the Open has ended the community is going strong so please come join us) to see if the dip in shares and poor performance now made CBI a buy?

Our winner, Jim Van Meerten, and his whopping gains of nearly 40% had this to say about CBI, "I really think this stock has been overly pounded."

Jim is big into the numbers and likes to follow the charts. With CBI he suggests that investor wait until the stock trades at or above $35 per share.

"It has a resistance level at 34.86 so I'd buy if it could get to 35. At 35 it will be trading at its 20 day moving average and that could be a buy signal."

Well the stock traded for above $35 today, but fell back below that number as the rally in stocks fizzled a bit. I suspect technicians like Van Meerten will look very closely at other data to determine if the stock is worthy of investment.

One of our other top players, Russ of RD's Picks took Van Meerten's advice and looked at CBI's opinion on www.barchart.com. Doing so provided a rather sober conclusion regarding the stock as nearly every indicator was negative.

"Foster Wheeler (FWLT), with a similar business profile, trades at 13 times 2009 estimates. That PE premium seems justified based on a higher projected growth rate. On a one-year chart, CBI and FWLT traded nearly in tandem until late April, probably CBI's last earnings report. They then tracked in parallel until mid-July where CBI took another drop corresponding to the pre-announcement call."

In my Rational Investor world I call that inefficient pricing brought about by a short term phenomenon. Clearly CBI will be in trouble if it continues to take earnings hits like it did recently, but if the troubles are behind it the market should return to equilibrium.
Russ is not convinced the end has been seen. He states that the company has missed earnings estimates in 3 of the last 4 reporting quarters. That is not a good track record and does not bode well for the future.

Markets are treating earnings misses with huge losses of valuation as evidenced by CBI action in mid-July. This is not the kind of market to be messing around with uncertainty. Then again, such a state is conducive to rich rewards for those that do take the risk.

We are at an inflection point with CBI. In the long term, the global growth story would suggest that huge construction projects will keep the company's backlog strong for some time to come.
That being said, it may be best to take a look at other firms in the space that may have a better operating track record. I'll let Russ have the last word:

"If you believe the project risk problems are behind them, CBI looks attractive. However, I think FWLT is a better buy in the engineering and construction space. I didn't check, but Fluor (FLR), Jacob's Engineering (JEC), McDermott (MDR) and others would also be worth a look."

by The Freshman |  08/01/08  |  Stocks: , , , , ,

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