Image Source: Chicago Bridge
We’ve lowered our fair value estimate for Chicago Bridge & Iron.
By Kris Rosemann
We’ve lowered our fair value estimate to $18 from $34 and widened our margin of safety for Chicago Bridge & Iron (CBI) after it cut its bottom-line guidance for 2017 and suspended its dividend August 11. Management may not have the best handle on its business at the moment, as evidenced by the number of projects it was forced to take a significant charge on doubling from two to four from the first to the second quarter of 2017. The bottom-line guidance reduction can be used as evidence of how precise and transparent management has been of late. The company expects second half earnings per diluted share to be in a range of $1.00-$1.25 after reporting a loss of $2.87 per diluted share from continuing operations in the first half of the year; initial diluted EPS guidance for the year was $4.00-$4.60, and the first guidance revision was to a range of $3.50-$4.00.
Management has also changed its tune with respect to its E&C margin assumptions moving forward. On its first quarter conference call, management stated its belief that it would be able to return to historical margins in the second quarter of this year (before new projects ramped up), and it painted one of the LNG projects in which it was forced to take a majority of $367 million charge in a positive light. The company now expects E&C margins to be in the lower end of the 4%-7% range on a go-forward basis, not just for the back half of 2017 as margin headwinds are expected to persist in LNG projects in its backlog. We’re not convinced we’ve seen the end of cost overruns on the four projects in question, or any similar projects in its backlog. The cash burn may only be beginning, and management does not expect meaningful growth in its backlog, which is a shell of its former self, until at least the back half of 2018.
Chicago Bridge & Iron also announced a cost reduction plan that it expects to result in $100 million in annual savings in 2018, and the suspension of the dividend is expected to result in cash savings of $28-$30 million a year. The company can use any savings it can identify at this point as it used ~$466 million in cash in operating activities in the first half of 2017. Management also plans to sell its Lummus Technology business by the end of 2017, which it expects to fetch a price tag of $2+ billion along with favorable deal terms regarding co-operation moving forward. The sale of yet another ancillary business, a relatively highly profitable one at that (operating margins of 30%+), is another sign of a business that is strapped for cash, and the first priority of the use of the proceeds from the sale are to be for future covenant compliance. It is worth noting that the entirety of the proceeds from the recent sale of its Capital Services business was used in debt reduction.
CBI’s most notable covenants include new (as of August 9, 2017) minimum trailing twelve months EBITDA covenants as follows: $500 million for the end of September 2017; $550 million for the end of December 2017; $500 million for the end of March 2018; $450 million for the end of June 2018; and $425 million for the end of September 2018. These EBITDA figures include an add back provision for certain project charges, and this adjusted EBITDA figure came in just under $400 million for the first six months of 2017 (not on a trailing twelve month basis).
Though CBI may not be in immediate danger of violating its minimum EBITDA covenants, management is still working to right-size its balance sheet and improve its internal processes in bidding on and executing major contracts. We maintain our view that confidence in management should be taken with a grain of salt, and a similar feeling has been permeating throughout the markets. There may be some valuation upside potential in shares, but there remains a significant amount of downside risk as multiple credit amendments, asset sales, and guidance reductions are never signs of a healthily functioning business.
Engineering & Construction: ACM, CBI, EME, FLR, GVA, JEC, KBR, LAYN, MDR, PWR