Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
After enjoying a huge jump yesterday, shares of construction firm Chicago Bridge & Iron (NYSE:CBI) could be poised to enjoy another winning day Wednesday. For this, you can thank the friendly analysts at Wells Fargo, who upgraded the stock this morning.
Here are three things you need to know about that.
1. When risks abounded
Chicago Bridge & Iron stock has been under pressure for some time now, falling 85% from its March 2014 high to a recent low of just $13.15 earlier this month. Things had gotten darkest on June 21, when Australian investment banker Macquarie labeled CBI stock a sell and cut its price target on the stock -- which had once traded above $85 a share -- to just $10.
Macquarie made its call based on the belief that Chicago Bridge & Iron was facing delays in constructing a liquefied natural gas plant in Freeport, Texas. These delays, combined with other issues, put the company's cash flows at risk, and could even threaten to tip the company into insolvency, warned Macquarie.
And yet, the very same day that Macquarie issued this warning, Macquarie also retracted it -- admitting there probably would be no delays in constructing the Freeport plant. (Instead, Macquarie said, Chicago Bridge would probably hire more workers and pick up the pace to get the project done on time, incurring higher labor costs. For this reason, the analyst said, it was sticking with its negative opinion of the stock despite undercutting its own reasoning for making the negative call in the first place.)
2. Nuclear meltdown averted
A second cause for worry over Chicago Bridge & Iron stock was the lawsuit that Toshiba subsidiary Westinghouse filed against the company in 2015. In that lawsuit, Westinghouse sought $2 billion in compensation for alleged accounting issues at Chicago Bridge, reliance upon which had induced Westinghouse to buy Chicago Bridge's Shaw nuclear construction subsidiary.
But yesterday, that worry, too, went away, when a Delaware court ruled in Chicago Bridge's favor and threw out Westinghouse's accounting claims. In so doing, the court removed a $2 billion cloud of worry overhanging Chicago Bridge & Iron's stock -- prompting Macquarie to raise its price target to $14 a share, and Wells Fargo to upgrade the stock to buy.
As StreetInsider.com (requires subscription) explained in a note this morning, Macquarie had previously subtracted "~$3.60 per share" from Chicago Bridge & Iron's valuation based on the risk of Westinghouse winning its lawsuit. Today, Macquarie says this litigation risk has been "largely removed."
3. Wells Fargo's read
Wells Fargo's reasoning is similar. As Wells calculates it, when the court threw out Westinghouse's accounting claims, it cut Chicago Bridge & Iron's potential liability in the lawsuit from $2.2 billion to $100 million. It also increased the value of this $20 stock to a new price target of $28.
What it means for investors
Wells still sees a host of issues plaguing Chicago Bridge stock, mind you -- potential charges to earnings for delays on construction projects, a CEO transition, and a weak balance sheet, among others. Still, Wells finds the stock's valuation intriguing at less than five times forward earnings. Wells suggests that Chicago Bridge could potentially fix its balance sheet issues by selling off its technology division, raising perhaps as much as $1.9 billion in cash, for example, yet still retain as much as $2.50 per share in annual earnings power from the divisions that remain. Is that enough to make the stock a buy?
Let's crunch some numbers:
Proceeds of $1.9 billion from selling one division would permit Chicago Bridge to retire most of its $2.4 billion in debt. Plus around $400 million in cash on hand, it could even reduce the company's net debt to essentially zero. For a stock trading at roughly $20 a share, $2.50 per share implies a P/E ratio of 8. With no debt to muck up the valuation, that seems like a pretty cheap price for a stock that, according to analysts polled by S&P Global Market Intelligence, is likely to grow earnings at more than 9% annually over the next five years.
I think Wells Fargo is making the right call here. Although Chicago Bridge & Iron stock still has issues, it's cheap enough to buy.