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Bear Hug For Chicago Bridge and Iron

By Linda McDonough on June 28, 2017

Shareholders of Chicago Bridge and Iron (NYSE: CBI) are enjoying an industrial strength boost today. The stock is up 34% versus a double-digit decline in the S&P 500. It’s a long overdue bounce for stockholders who have been mercilessly pummelled in the stock.

The bears, which no one ever pities, are suffering the flip side pain due to an unexpectedly favorable court ruling for Chicago Bridge and Iron. Short interest has risen 28% in the last three months as the stock fell 55%.

The court ruling applies to a disagreement between Westinghouse Electric and Chicago Bridge over a 2015 acquisition. Westinghouse Electric purchased Chicago Bridge’s nuclear construction business for nothing upfront. Both sides agreed that adjustments for cost would be made at a later date. Westinghouse claims that Chicago Bridge owes it $2 billion due to cost overruns. Yesterday the court ruled in Chicago Bridge’s favor, clearing it of the gigantic liability.

Up until this week, Chicago Bridge has been a short seller’s dream. The stock, which began the year at $33, immediately started drifting down as investors fretted that Trump’s infrastructure spending plan might not be as robust as expected.

Late February is just about the time that I recommended a put position in Chicago Bridge for subscribers of Profit Catalyst Alert. I placed the bearish bet with the rationale that investors were hoping for too much too soon from industrial companies.

I timed the bet to coincide with first quarter earnings when the company might deliver disappointing guidance. Chicago Bridge’s business, in particular, is correlated tightly to energy and oil and gas customers, not government infrastructure projects.

However, Chicago Bridge’s problems extend well beyond the lack of funding for government projects. Results were significantly worse than I imagined.

Indeed, when Chicago Bridge reported its fourth quarter on February 28, earnings equaled $.85, just a bit more than half of the $1.50 expected. The problems stemmed from fixed price contracts, which make up more than three-quarters of Chicago Bridge’s business.

Chicago Bridge experienced massive deterioration in worker productivity in these projects, forcing the company to hire external workers. The costly and restrictive work rules for these newly added workers sliced its profits to the bone.

Investors gave the company a free pass, and the stock closed down just slightly. Fast forward three months to the first quarter earnings release on May 8th when operational costs continued to run rampant. Once again the company delivered atrocious earnings.

Earnings amounted to a mere $.24 versus the $.92 expected. The bears danced with glee as the stock gapped down to $26 and slid to its recent low of $13.50. Top to tail, the stock dropped 59% and 57% from the level that I executed the put purchase.

The stock traded over 32 million shares yesterday, well above the 11 million shares short. It’s quite possible most bears covered their short positions as most still held a sizable gain in the stock. The question now is whether the resolution of the Westinghouse suit is worth the $500 million of market cap added to the stock on the news.

I recommended selling those Chicago BridgeI puts in early March for a 36% gain in two short weeks. While I wish I had held them longer for a bigger pop, I’m hoping to leverage the research invested in the stock for future trades.

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