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A Bridge Not Far Enough: Chicago Bridge and Iron (CBI)

Chicago Bridge and Iron (CBI) is in the engineering and construction business with customers in the energy and natural resources business. At first glance, the company looks inexpensive, selling at a PE of 11 times 2009 earnings estimates and only 2/3 of sales.

As is frequently the case, there is a 'but.' On 15 July, CBI pre-announced their 2nd quarter earnings. They will be taking a $317 million, or $2.38 per share, pre-tax charge to cover costs related to two ongoing construction projects in the UK. That charge is expected to cover the projects through completion. The problems stemmed from unusual weather conditions and labor issues with subcontractors. They are taking steps to reduce risk in projects going forward. Without the problems on these two projects, the CEO stated they would have beat estimates.

The company isn't in any danger of going out of business; there's plenty of net cash on the books. However, the charge off did trigger some covenants on their credit lines. They are negotiating with the creditors and those talks were reported to be going well.

I followed vanmeerten's advice and took a look at the CBI opinion on Barchart.com, nearly every indicator was a sell.

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.

This one is a tough call. I think energy and natural resources infrastructure still has some life left, although the easy money's probably already been made. CBI does have a couple of recent, significant contract announcements. The two problem projects in the UK along with recent market weakness have CBI trading at an attractive valuation. If the most recent charge really is the last write down associated with the UK projects, the company should close the gap with its peers. It would need to tack on about 12% to get back in lock-step with FWLT. However, I'm not sure the stock price is fully discounting the problem projects. CBI's recent earnings report history isn't stellar, Yahoo finance shows they've missed estimates three of the last four reports.

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, Jacob's Engineering, McDermott and others would also be worth a look.

Comments: View Comments |  Wednesday July 30, 2008

Archive Comments (1)

Russ,

Checking Morningstar, their analyst says a majority of CBI's contracts in backlog are fixed cost - they bear the risk of overruns.

About 5 years ago I invested in Shaw Group (SGR), and they had a series of overruns, followed by a capital raise, which went better than I would have expected. They have since gone over to cost plus contracts and the stock has done well. I lost a little money going long and made it back going short.

If CBI got to where they needed a capital raise,such as if they can't get waivers or revised covenants, the capital raise would attract short-sellers. Up until recently, banks seemed fairly lenient in granting waivers, but recently I have several cases I invest in where negotiations seem to be dragging on.

I missed the E&C boom so it would be tempting to try to find an entry point, but my past experience with fixed cost overruns was not good.

Tom

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