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Strategies & Market Trends : Value Investing

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To: Graham Osborn who wrote (55675)	7/12/2015 7:12:59 PM
From: E_K_S	1 Recommendation Recommended By bruwin Read Replies (2) of 78645

Re: Chicago Bridge & Iron Company N.V. (CBI) Jacobs Engineering Group Inc. (JEC) Fluor Corporation (FLR) -NYSE My takeaway is Goodwill (which is an intangible asset) is quite large. Can you think of this cost as a 'sunk' cost? This is/was the price that had to be paid to acquire the real producing assets and to amortize this Goodwill 20 years into the future is not piratical and/or a reasonable valuation method for the future FCF of the entire enterprise. So, what if you just cut the BV in half to $13.00/share (down from $26.00/share). The logic here is that 50% of the stated BV is a better representation of the true value of those producing assets acquired through acquisition. The rest (ie Goodwill) is just sunk costs. What valuation is the company worth using the GN formula? I arrive at something around $40.00/share. Then the future valuation would be one of (1) how fast does BV increase from that discounted level and (2) the growth of EPS as their book of business grows (both larger contract size and higher margins from the efficiency gained by past acquisitions). The latter could/would eventually result in PE expansion. If you now compare CBI to a similar company like Fluor Corporation (FLR), FLR's forward PE is 37% higher than CBI (ie 11 vs 8). I would speculate that the market is undervaluing CBI's PE and the quality of their future earnings. If that PE expansion occurs then one could make the argument that CBI is worth $60.00/share (ie fair value) not $46.50/share. There is also the question of the possible liability for the cost overruns (ie liquidated damages) from their Southern Co. contract work where Westinghouse Electric, and CBI are the contractors. Assume $600mln total liability and that is shared 50:50 w/ Westinghouse Electric (parent is Toshiba) that comes out to $3.00/share in damages to CBI (worst case). Therefore, one could make a credible argument that CBI's fair value is $57.00/share ($60.00/share - $3.00/share). That estimate accounts for (1) overstated Goodwill by 50%, (2) PE expansion reflecting the quality of earnings and growth in their order book and (3) an adjustment to fair value (50% of the potential liquidated damages) for contract overruns (ie Southern Co nuclear contract). ------------------------------------------ I still think CBI is at least 20% undervalued from their current price. The key for me is to continue to watch their order book growth and new contract awards. A diversified portfolio might want to also hold shares in Fluor Corporation (FLR) and possibly Jacobs Engineering Group Inc. (JEC). FWIW, JEC has a Graham valuation of $47.96/share. That represents a 19.5% undervaluation from Friday's closing price of $40.15/share. JEC also has a history of acquisitions but not as aggressive as CBI. They recently (4/2015) obtained a controlling interest in a Chinese chemical engineering company providing them w/ future growth possibilities in China. Jacobs Acquires Controlling Interest in Suzhou Han’s Chemical Engineering Company More food for thought. EKS

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