Could Hot Gas Play Spring a Leak?
By NAUREEN S. MALIK
CENTURY-OLD CHICAGO BRIDGE & IRON wowed Wall Street by reinventing itself to become an engineering-and-construction firm catering to the energy sector.
But tougher comparisons after strong growth and concerns about the economy mean this stock could start to lose some gas.
The company that started building bridges across the United States in the late 1800s became a Wall Street darling in recent years as one of the few ways to play demand for liquefied natural gas (LNG), one of the fastest growing segment in energy. CB&I builds liquefaction facilities and cryogenic tanks that remove impurities from natural gas and compress it in liquid form.
That has resulted in an outsized valuation and stock price. Shares are up 95% this year alone and have increased more than ten-fold in the past five years.
Big energy companies have been funneling cash flow from rising commodity prices into projects that expand existing production facilities or building new ones to meet growing global demand for energy.
And CB&I has been at the center of that movement. LNG accounted for 60% of the company's awards of $4.9 billion for the first nine months of 2007, boosting CB&I's backlog of contracts for new projects to $6.4 billion.
While CB&I has been getting more positive attention from Wall Street as of late, the good news is already baked into the stock.
At a Glance
Chicago Bridge & Iron
Stock Price: $52.03
52-Wk High: $56.49
52-Wk Low: $25.79
Market Cap: $5.02 billion
Est. 2007 EPS: $1.74 per share
Forward P/E: 29.9x
Est. Long-Term EPS Growth: * 22%
Est. ('08/'07) EPS Growth: 34%
Revenue (trailing 12 months): $3.9 billion
Dividend Yield: 0.30%
CEO: Philip K. Asherman
Headquarters: The Hague, Netherlands and Woodlands, Texas
* Based on analyst estimates looking ahead three to five years.
Sources: Barron's Online, Thomson Financial/Baseline, Yahoo! FinanceDavid Yuschak, managing director of emerging growth at SMH Capital, says the reasons he was bullish on CB&I for the past three or four years -- the potential to win big contracts amid LNG growth expectations -- "have played out."
He recently downgraded the stock to Sell on concern over where the potential upside surprises would come from. And in the intermediate term, "we couldn't answer that question," says Yuschak.
Growth is all about the backlog of contracts for new projects and the profitability of executing them, says Stanford Group analyst Philip Dodge. By contrast, take a look at industry leader Fluor. Shares have plunged 22% since late October on lower-than-expected earnings and concerns about softer growth of its backlog due to already high levels.
Rising commodity prices pulled CB&I out of a slump several years ago, but the too-rapid rise in the commodities can actually work against the company. Although revenues are rising, energy companies are grappling with higher costs.
It is unclear whether the current rise in oil prices is driven by speculators or more sustainable supply-and-demand fundamentals. That is making it difficult for energy companies to make investment decisions, says Yuschak.
Though oil prices are well over $90 a barrel these days, a drop to $70 would change the benefits of some marginal projects, he notes.
Goldman Sachs engineering-and-construction analyst Chris Hussey is bullish on CB&I but says that stocks in the industry tend to move with oil prices. "When oil prices do well these stocks go up and when oil prices go down they tend to underperform the market," he says.
This changes the perception of the stock but not necessarily the fundamental picture in the intermediate term. Many of CB&I's projects are based on expectations of $40-to-$50 per barrel of oil and $4-to$5 per million British thermal units of natural gas, says Marty Spake, the company's director of investor relations.
The flurry of new engineering-and-construction projects is straining resources, stretching the talent pool of engineers and other experts.
Early third quarter results indicated that the energy companies' commitments to capital projects have moderated, noted Yuschak. This suggests that CB&I's backlog may be peaking. Big oil firms have a history of using excess cash flow to buyback shares.
These valuations, Dodge adds, already take into account the $950 million acquisition of Lummus Global, which specializes in technology used by energy companies, that is expected to close Friday. This will allow CB&I to get involved with projects earlier in the planning phase.
The bulk of CB&I's business has been based in the U.S. but it should be an even split with international clients in 2007, says Spake.
Strong demand for services has allowed CB&I to increasingly take on jobs as a primary contractor for large projects rather than a subcontractor for one of the large-capitalization companies, says Hussey.
This raises the company's profile but also increases the risks when individual projects run into glitches. Five years ago, CB&I had hundreds of projects versus 20-30 projects that make up 80% of its backlog, notes CB&I's Spake.
High labor costs at a U.K. project and changes to another project in the U.S. "had a pretty significant drag on our profitability," says Spake. He says gross profit could come in just under the 9-11% gross profit margins range the company talked about, says Spake. Overall, he says, the company is confident about its growth prospects.
Even in an extended cycle of demand for engineering and construction services, these factors bode ill for CB&I's valuation, notes Stanford's Dodge. Knocking the valuation premium out the stock could drop shares down to the $30 range from its current price of $52.03.
The stock is trading 30.7 times 2007 consensus earnings estimate and 23 times the 2008 estimate. On an enterprise value/earnings before interest, taxes depreciation and amortization, CB&I is trading at roughly 13.8 times, a 48% premium to its historic average of 9.3 times, Dodge says.
More speculators appear to be playing CB&I and the industry. SMH Capital's Yuschak notes that turnover of the entire shareholder base in the industry changes hands every three months. Shareholder turnover took six months a year ago.
Given the momentum behind engineering-and-contracting service companies, CB&I could continue to trade higher, particularly if the company scores some stellar new contracts and improves margins.
For the most part, though, continued growth expectations are already well priced into CB&I's shares and the valuation looks lofty given the greater risk factors it is facing.
News 
Market Data 
Discover 
AI
