Chicago Bridge & Iron: A Strong Buy On Brexit Uncertainty

| About: Chicago Bridge (CBI)

Summary

Shares of Chicago Bridge & Iron have been hammered as a result of fears over the Brexit and what it could mean for the business.

However, while forex fluctuations are likely to have some impact, the firm's high quality business model and U.S.-centric backlog is unlikely to be materially impacted, if at all.

Add to this the low trading multiple on the business this year and it's hard to see why Mr. Market doesn't like shares right now.

The past couple of trading sessions have been anything but pretty for stocks in general but one of the companies that has been hit the hardest has been Chicago Bridge & Iron (NYSE:CBI), which has seen its market value hit to the tune of $488.5 million, as of the time of this writing, over a two day period. In what follows, I will look at the company and discuss why I believe Mr. Market likely overreacted to the news associated with the Brexit that caused shares to tank and discuss what I believe about the overall business as a whole.

The impact of a Brexit is uncertain

Truth be told, the impact of a Brexit on CBI is impossible to know without further information from management (which I suspect we will be receiving in its next quarterly release). However, we can get a good idea of where the impact will likely be and get probably a good sense of the size range that it might be. First, however, we must distinguish between two forms of impact on CBI: fundamental and forex. Fundamental changes imply potential impacts associated with the company's sales (will it lose business, for instance) and forex implies the impact of foreign currency fluctuations.

The first is probably the easiest to tackle because more data is known about the fundamentals of the company. In its first quarter this year, due to the low energy price environment, CBI saw its backlog fall to $21.16 billion, a drop of 6.5% from the $22.64 billion seen during the last quarter of 2015. This came as a result of low new awards during the period of just $1.20 billion while the company's sales were $2.67 billion. The revenue number for CBI was actually lower than the $3.13 billion in sales seen the same quarter a year earlier but after you strip out the business's recently-divested nuclear operations, sales were up from last year's $2.64 billion.

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It's difficult to tell what the picture will look like moving forward on the sales front, but if management is correct, the firm should generate revenue this year of between $11.4 billion and $12.2 billion, a good uptick from last year's when (excluding its nuclear business) the top line was $10.9 billion. Whether this can still transpire is something only time will tell but given CBI's track record, I wouldn't put it past management.

The big fear many investors may have regarding this, though, is that backlog may take a hit as a result of the Brexit move, something that should technically cause some weaker demand revisions for energy, ceteris paribus. However, I believe this to be unlikely for CBI because of the fact that around 80% of the firm's backlog comes from the U.S., with the remainder coming from elsewhere.

Unfortunately, management does not break this extra 20% down, but when you look at year-end geographic data provided by the firm regarding sales for last year, as shown below, you get a good idea that only a small amount of sales is likely attributable to Europe. No country outside of Australia and the U.S. accounted for more than 10% of CBI's revenue in 2015 and all countries outside of these two made up just 18.2% of revenue as a whole. This, to me, makes the probability of a meaningful drop in backlog as a result of contract cancellations quite low.

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The other risk involves foreign currency fluctuations, which are important to any international business. Take, for instance, the latest quarter of information provided by management. During that quarter, a rise in the dollar relative to both the Australian dollar and the euro managed to negatively impact accumulated other comprehensive income for CBI by $21.4 million and reduced cash on hand by $8.3 million. It's impossible to tell how much the company will be impacted by recent movements, which has the dollar up about 2.7% compared to the euro, but investors shouldn't be surprised to see some negative move on this front.

Shares look extremely cheap

Overall, I do suspect that the Brexit decision will ultimately have a negligible impact on CBI (probably none from a revenue/backlog standpoint but certainly something (probably modest) from a foreign currency standpoint). This leads me to remain confident in the value proposition provided by management, which is that the firm is a high quality business whose shares are trading at an incredibly low level right now.

If we are to assume, for instance, that management's guidance earlier this year is correct, CBI should generate earnings per share this year of between $5 and $5.75. With the company's stock currently trading for $32.39, this implies a price/earnings multiple on the business of between just 5.6 and 6.5, making it one of the cheapest companies I've been able to find in recent years. Now that the firm's bad egg of a nuclear business is gone, management also anticipates that operating cash flow this year will be as high as, if not higher than, the company's net income, meaning that its price/operating cash flow multiple will be either at or below the firm's earnings multiple range.

Takeaway

At this moment, Mr. Market is freaking out over CBI, but I don't see a good reason for it. Yes, there will likely be some impact on the enterprise thanks to the Brexit (most likely in the form of foreign currency fluctuations) but it's difficult to imagine any such impact would be enough to warrant shares trading for as low as they are today on a forward earnings and operating cash flow basis. This is one of a handful or so of companies that I wouldn't personally worry about if I were to go into a coma and wake up 10 or 20 years from now — because in my opinion, absent fraud, the associated risks are more or less immaterial.

Disclosure: I am/we are long CBI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.