Chicago Bridge & Iron (CBI)

Equity Research Report

HERNDON CAPITAL MANAGEMENT

Summer 2016

Zaki Colabawala

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Table of Contents

Executive Summary 2

Industry Overview 3

Company Overview 6

Investment Thesis 8

Valuation 11

Appendix 12

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Chicago Bridge & Iron Co NV (CBI US) - CBI Historical Perf

In Millions of USD except Per Share FY 2008 FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 FY 2014 FY 2015 Current

12 Months Ending 12/31/2008 12/31/2009 12/31/2010 12/31/2011 12/31/2012 12/31/2013 12/31/2014 12/31/2015 07/18/2016

Revenue Growth Adjusted Year over Year — — -20.06 24.94 20.54 102.26 16.95 -0.35 -14.65

Gross Margin Adjusted — 11.47 13.80 12.82 12.79 10.81 11.30 11.70 10.78

EBITDA Margin Adjusted — 8.94 10.73 9.71 9.56 8.66 9.28 7.94 8.24

Net Income Margin Adjusted — 4.02 5.88 5.84 5.53 4.05 4.38 3.88 4.01

Return on Common Equity Adjusted — 25.64 22.18 23.81 23.83 24.22 22.38 21.12 22.29

Return on Assets Adjusted — 6.09 7.22 8.59 7.97 6.55 6.06 5.40 5.78

Price Earnings Ratio (P/E) 3.48 10.74 15.42 14.22 15.01 19.85 8.06 8.30 7.40

Enterprise Value/EBITDA 14.48 4.65 7.68 7.31 8.95 12.17 5.30 4.97

Price to Free Cash Flow — 9.64 12.24 9.95 34.39 — 30.98 — 13.56

Order Backlog Value — 7,200.0 6,900.0 9,000.0 10,900.0 27,794.2 30,363.3 22,643.9 21,200.0

Source: Bloomberg

Chicago Bridge & Iron (CBI) Executive Summary

Company Description: Chicago Bridge and Iron (CBI) is an integrated engineering and construction company that focuses on power and energy related infrastructure markets. The company is organized into four business segments: Engineering & Construction, Fabrication Services, Capital Services, and Technology. Chicago Bridge & Iron is widely considered to be a global leader in its respective space and serves customers ranging from sovereign governments to the largest oil & gas companies. Revenues during 2015 came from three regions: United States (65%), Australia (18%), Other (17%). Chicago Bridge & Iron collected most of its 2015 revenue from the Engineering & Construction segment (60%), and the Technology segment produced a segment operating margin (37.8%).

Investment Thesis:

CBI has performed well relative to the macroeconomic environment. The Energy sector’s performance over the last two years is no secret. It has become one of the most beat up spaces in the market. One could rationally conclude that a company who collects most of its revenue from this sector (like CBI) would be in even worse shape. Chicago Bridge & Iron, however, has gone against the grain in this instance. The company is separated into four diversified segments which touch on everything from building LNG ports to licensing CO2 capturing technology. This range of services has kept CBI relatively insulated (but not unscathed) from any drastic cuts in revenue.

An advantageous labor model. The energy space, namely the energy infrastructure space, requires highly skilled individuals to quickly and safely get jobs done. CBI has made groundbreaking progress in retaining its skilled laborers through a Self – Perform, Direct – Hire labor model. This model provides for all training to be completed in – house and limits reliance on outsourcing. Having this sort of operation in place during today’s industry environment will give CBI a step up against its competitors.

Technology segment is poised for explosive growth. The pipeline looks very promising with industry changing products to be released in the near future. Margins look extremely attractive here, and since Technology is only 3% of revenue there is room for scale by integrating technology offerings with current offerings.

Customer friendly business model. In a world where energy companies are feverishly chasing efficiency, CBI’s integrated business model makes life easier for customers. This trend is set to become a differentiating factor in the energy infrastructure space as the oil & gas space begins to rebuild and expand once more.

Key Risks:

Failure to realize backlog. This can result from project terminations, suspensions or changes in project scope and schedule. CAPEX spending is a good gauge of this risk potentially materializing.

Business indirectly beholden to market price of oil. This threat can cause volatile periods of earnings fluctuation.

Investment Conclusion: Overall, CBI has displayed impressive strength during recent industry stress. The company experienced a ramp up in business during the U.S shale drilling boom, but the subsequent bust has pointed out areas where it could improve. CBI has recognized these areas and is now hedged from market turbulence relative to where it was before the energy market crash. An example of CBI’s efforts to hedge itself from further market turbulence is the increased importance being put on the technology segment. This, along with other factors I will discuss in the following report, is why I am rating Chicago Bridge & Iron as a “Buy”.

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Industry Overview

The Oil & Gas Infrastructure Construction Services Environment:

The world’s energy infrastructure is comprised of many components including the physical network of pipes for oil and natural

gas, electricity transmission lines and other means for transporting energy to end users. This infrastructure also includes

facilities that turn raw natural resources into useful energy products. The rail network, truck lines, and marine transportation

are also considered components of America’s energy infrastructure. Companies considered part of the oil & gas infrastructure

construction services space conduct activities ranging from constructing LNG ports to developing technologies associated with

energy extraction. The sector as a whole has undergone significant changes in the past 10 years, and more are expected as

technology becomes one of the foremost drivers of success in this space. There are four current trends in this industry that I

think encompass its current state:

1. A “New Normal”

Around 10 years ago, a boom in demand for commodities started is called the commodities “supercycle”. This demand was

widely attributed to China’s seemingly unquenchable thirst for raw materials, and ultimately, their desire to build at an

incredible rate. The consequent explosive growth in commodity demand put the oil & gas infrastructure construction industry

in a great situation as petroleum and natural gas products rode this wave of demand. Large oil & gas companies invested

heavily in infrastructure immediately after the 2008 financial crisis in order to keep up with this demand, and also take

advantage of a relevantly new technology called “fracking”. This capital spending increase provided both economic stimulus

and confidence into shale driven oil and gas production, and thus, the oil and gas infrastructure landscape. This boom in

revenue was obviously great for the industry, but it also created a surplus in infrastructure projects. The subsequent bust in

prices during 2015 has placed the industry in difficulty as CAPEX spending from the oil & gas space has fallen dramatically.

This cycle of falling CAPEX spending will, like all cycles, pick back up. It will be a new world; however, as infrastructure

companies will face a “new normal” in their business model compared to the explosive growth period of 10 years ago.

Historical Oil and Gas Extraction CAPEX 2004 – 20016 (Bloomberg)

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2. Skilled Labor: A Disturbance in the Force

Skilled labor is becoming scarce as workers laid off during the commodity crash are not quick to come back. Many of these

workers have either retired or found work in other industries. This is not an uncommon occurrence during periods of industry

stress as a similar situation took place in the home construction industry. When the housing bubble burst in 2008, millions of

construction workers found themselves jobless. They had no choice but to retire or attempt to utilize their skills in another

line of work. To this day, the United States is about 28% below the rate of employment in residential construction from its

2006 peak. Below is a chart showing current employment in the oil and gas services industry. If the “brain drain” caused by

persistent layoffs in the energy infrastructure space continues, we could see a situation similar to what the construction

industry is currently experiencing during their rebound. Companies will be forced to pay a higher premium for skilled labor in

order to lure them back to the industry. This will beget delays caused by infrastructure companies being short-staffed.

Historical Oil and Gas Services Employment 1995 – 2016 (Bloomberg)

3. Political Polarization and Regulation

The 2008 financial crisis gave rise to a new era in political populist movements against big corporations. Aside from the

obvious antagonism towards investment banks, the energy sector picked up a share of bad press due to its perceived negative

impact on the environment. The Keystone XL pipeline is a perfect example of this as the pipeline itself would have only

represented less than 1% of total pipeline infrastructure in the country. This topic, as small as it may or not have been,

received an unprecedented amount of media and political attention. The bill was ultimately vetoed by President Obama in

early 2015. Political polarization and radicalization has given politicians the power to sway topics of economic interest in ways

that may not accurately reflect the situation. Topics regarding pending energy infrastructure projects, like the Keystone XL

pipeline, could increasingly be used as political pawns resulting in inefficient project flow riddled with delays. There could also

be a subsequent lowering in margin of error for infrastructure companies as any missteps could be magnified and ruin a firm

whereas this may not have been the case during politically moderate periods. Below is a Pew Poll depicting America’s attitude

between typical energy production and alternatives.

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4. Demand for Integrated Infrastructure Services

As infrastructure clients in the energy space continue to emerge from the commodity price bust, integrated infrastructure

business models are a trend that will complement the ensuing environment. The concept of an infrastructure company being

able to deliver a variety of services is not new; however, it could prove to be a major differentiator between companies that

receive the most business versus those who get left out in the cold. The large vertical integrators in the infrastructure space

stand to gain a tighter hold on their own costs and can potentially draw themselves closer to their customers.

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Company Overview

Chicago Bridge & Iron, 125 Years of Experience and Excellence:

Chicago Bridge & Iron was founded in 1889 in The Netherlands. The firm provides a wide range of services including

technology, modularization, construction, commissioning, and decommissioning to customers in the energy infrastructure

market worldwide. The stock trades on the New York Stock Exchange under the ticker “CBI”. With over 42,000 employees

and operations in over 70 companies at any given time, CBI is one of the larger companies in its space.

Recent M&A and Disposition Activity Description

On February 13, 2013, CBI acquired Shaw for a gross purchase price of approximately $3.4 billion. This deal comprised of

approximately $2.9 billion in cash consideration and approximately $488.8 million in equity consideration. The results from

the Shaw acquisition were incorporated with CBI’s reporting beginning on the acquisition’s closing date. The acquisition

increased CBI’s capabilities in power generation, environmental management, infrastructure, and manufacturing. On May 17,

2013, CBI acquired a coal gasification technology (E-Gas) for cash consideration of approximately $60.8 million, primarily

consisting of process technology intangible assets. This acquired business has been incorporated within the Technology

operating group. I will speak to this technology later in the report as it provides a key source of growth for the business. On

October 27, 2015, CBI entered into an agreement with Westinghouse Electric Company to sell its nuclear power construction

business. The sale was completed on December 31, 2015, for an estimated transaction consideration of approximately $161.0

million. This amount will be received upon WEC’s substantial completion of the segment’s current nuclear projects. As a

result of the sale, a non-cash pre-tax charge of approximately $1.5 billion ($1.1 billion after tax) related to the impairment of

goodwill (approximately $453.1 million) and intangible assets (approximately $79.1 million) and a loss on net assets sold

(approximately $973.7 million) was recorded for 2015.

Business Segments

During the first quarter of 2015, CBI realigned its four operating groups to reflect operations more accurately. The

maintenance business, which was previously reported within Engineering & Construction, is now reported within the Capital

Services operating group. The engineered products business that was previously reported within the Technology operating

group is now reported within the Fabrication Services operating group.

- Engineering and Construction: Considered by CBI to be its legacy segment, the EPC (Engineering, Procurement, and

Construction) segment accounts for the majority of revenue and is most exposed to this segment. Examples of projects

that this segment conducts are upstream and downstream refinery process units, petrochemical facilities, LNG

liquefaction/regasification terminals, and fossil electric generating plants. The EPC segment accounts for 57% ($1.5B) of

revenue and 55% ($11.8B) of backlog. The backlog composition for this segment regarding customer type is 50% LNG,

30% Petrochemical, 15% Power, and 5% Refining.

- Fabrication Services: The Fabrication and Services operating group is involved with the fabrication and erection of steel

plate structures, piping systems, and engineered products. Specific activities include pipe fabrication, pipe assembly, and

steel tank capabilities. According to management, CBI is the largest pipe fabricator in the United States which gives it a

considerable advantage. The company’s management stresses, however, that being the largest pipe fabricator does not

mean they bid on every project to take advantage of their own size. The company says it is sure to be very selective

regarding prospective projects, looking into only high margin opportunities. This segment accounts for 19.4%

($517.6MM) of revenue and 14% ($3B) of backlogs. The backlog composition regarding customer type is 45%

petrochemical 25% LNG, 15% Power, 5% Refining, 5% Gas Processing, and 5% to other end markets.

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- Capital Services: The Capital Services segment is key to CBI’s integrated approach as it can be thought of in an operation

and maintenance capacity. In this segment, the company undertakes program management, maintenance services, and

similar activities. This business provides very dependable recurring revenue strength which opens the door to very close

customer relationships. CBI’s Capital Services segment accounts for 21% ($569MM) of revenue and 5% ($5.4B) of

backlog. The backlog composition is made up of 65% operations/maintenance, 15% environmental services, 10%

construction services, and 10% project/program management.

- Technology: CBI’s Technology segment is a one that management considers to be a differentiator. Some specific projects

that this segment pursues are licensed process technologies and catalysts, process planning, project development, and

aftermarket support. The Technology segment’s portfolio has worldwide recognition in the olefins space and is widely

regarded as the world leader in heavy oil upgrading technologies through its joint venture with Chevron. Partnerships in

the Technology segment are typically split 50 – 50 or in some cases 30 – 30 – 30. The segment accounts for 3% ($64MM)

of revenue, and 5% of ($963MM) of backlog. Since this segment is still very much in a growth phase, there is not a

substantial backlog.

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Investment Thesis

1. Display of Strength amid Oil Crash

An integral part of any successful business is diversification. This is especially true when a company depends on a cyclical sector

like energy to provide the majority of its revenue. This concept should not be looked from simply a business segment

standpoint, but a geographic standpoint as well. Chicago Bridge & Iron has shown competence from both standpoints as it

offers diversified services in the energy space along with a differentiated global footprint. On the business segment front, the

firm is split into four areas: Engineering & Construction, Fabrication Services, Capital Services, and Technology. I believe each

segment does a great job of exploiting specific characteristics of the energy infrastructure space. The engineering &

construction segment stands the most to lose during times of macroeconomic turmoil as it relates to energy prices. However,

it also stands the most to gain when prices are soaring. This is definitely a threat that management has little control over.

Although the current environment has presented difficult situations, I believe there is still something positive to be said about

this segment’s exposure to oil prices. During times of stress, a major oil company’s main goal is to preserve as much market

share as possible. This has been exemplified by our good friends in Saudi Arabia regarding their nonchalant attitude towards

prices in the name of market share. The dynamic between price and market share is a sort of “Prisoner’s Dilemma” situation

that I believe can be applied to specific oil companies as well. When large drillers like Chevron and Exxon feel that their

market presence is threatened, they will be more likely to ramp up drilling since they can afford a slight decrease in

profitability. Considering the fact that CBI retains some of the largest drillers in the world as customers and is a world leader

in the industry, I believe CBI is in the best relative position to weather this current storm. I am focusing on this segment

because it is the highest contributor to revenue, but arguments can be made for the remaining segments as well. The

Fabrication Services segment is, according to management, the largest pipe fabricator in the country. This gives the company

the luxury of picking and choosing projects of their liking and those that provide the best margins. It also gives the company a

better chance of keeping their backlog relatively full. The Capital Services segment can be thought of as an operation and

maintenance organization. Although this segment has the lowest margin of the four segments (2%), I believe its value shows in

how well CBI is able to retain customers as it provides lifecycle services for infrastructure assets. I will talk about the

Technology segment more in another investment thesis point since I feel it deserves its own spotlight. As it relates to

diversification of the business, however, it must be noted that the energy sector is constantly seeking ways to improve

efficiency. Having a technology segment that provides cost saving products will help CBI ride the wave of cost cutting I expect

from the energy sector once it emerges from its current state. Below is a visual depicting the company’s EBITDA margin

strength over five years. Although margins have dipped recently, the company has recovered from worse situations. Visual

Source: Bloomberg

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2. An Efficient Labor Model

As I mentioned in the industry overview, retaining skilled labor is a looming threat. Chicago Bridge & Iron is actively

mitigating this risk by implementing a Self – Perform & Direct – Hire labor strategy. The self – perform component of this

strategy gives CBI much more control over project activities than they could have if work was outsourced. The ultimate result

is avoidance of cost overruns and thus a low chance of tarnishing of reputation. Chicago Bridge & Iron’s direct – hire

component is a system that is somewhat unique to this space. Many infrastructure companies outsource their laborers, but CBI

has the advantage of hiring, training, and retaining their own work force. These workers stay with the company and move

from one job to the next, taking their accumulated experience with them. Management has indicated that they are making

conscious efforts to grow the company’s training programs and make them even more robust. The combined implementation

of self – perform and direct – hire generally reduces risk by increasing schedule reliability and allowing project teams to

quickly tackle short – term setbacks. For example, if equipment is late to a construction site, field forces can be quickly

disbursed to avoid labor cost overruns. If emergency fabrication is needed in the field, CBI can quickly get an in – house

fabrication team to the site. Not having this self – reliance themed strategy would severely hinder schedules, and eventually,

profitability.

3. Great Opportunities for Growth in the Technology Segment

Chicago Bridge & Iron’s Technology segment has been identified as management to be a differentiator in the coming years.

After analyzing the segment’s future prospects, I wholeheartedly agree with management. The Technology segment, as it

stands today, has a pipeline that will potentially disrupt the entire field by exploiting efficiency and environmental issues. An

example of such technology is E-Gas. This coal gasification product turns coal and petroleum coke into synthetic natural gas.

Additionally, it is capable of removing in excess of 95% of mercury from coal and recovers 99% of sulfur produced from this

process. As you can see, the value in this technology is multipronged and will be attractive to various companies in various

businesses across the energy space. Another exciting example of CBI’s technology potential is its NET Power product. NET

Power is a gas-fired product based on CO2 power cycle technology which captures 100% of excess CO2. Its power

production capability is competitive with current fossil fuel technologies. The intended use is production of high-purity carbon

dioxide for use in enhanced oil recovery or sequestration. Demonstration of this technology is set for 2017 and its placement

in a commercial plant is slated for 2019. The company undertakes its technology ventures on a 50 – 50 or 30 – 30 – 30

partnership basis, yet still manages to register segment margins in the 41% range. I am very excited to see how this high

margin will translate to bottom line growth once the NET Power technology is on the market. Below is a visual of the NET

Power process. Visual Source: CBI Investor Day Presentation February 2016

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4. Industry Shift in Demand towards Customer Friendly Services

In a world of increasing competition for market share, customers will seek out infrastructure companies that have the ability to provide a vertically integrated array of services. I touched on this concept earlier in the report as an emerging industry trend. Chicago Bridge & Iron is perfectly positioned to profit from this demand since it already provides a plethora of services related to energy infrastructure (see graphic below). From a business segment standpoint, I believe each segment plays an integral role in making CBI the “one stop shop” it is today. The Construction and Engineering segment establishes the beginning of a client relationship through physically building assets, the Fabrication Services segment supports C&E through in – house pipeline fabrication, and the Capital Services segment implements the “Lifecycle Management” approach through maintenance servicing and program management. CBI’s Technology segment is, in my opinion, the X – Factor that completes the company’s integrated approach by drawing attention to the rest of the business while simultaneously growing the bottom line. Visual Source: CBI Investor Presentation June 2016

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Valuation Metrics

NameTicker

Mkt Cap ($M)Rev Gr Adj YoY

Grs Mrgn AdjEBITDA Mrgn Adj

NI Mrgn AdjROE FY1

5Yr Avg Adj ROEROA Adj

P/E FY1EV/EBITDA FY1

P/FCF:YP/FCF:Q

Order Bklg Val

($M)

Average4956

16.259.94

7.583.34

12.7715.38

4.5211.84

6.7221.96

12.9826192

CHICAGO BRIDGE & IRON CO NVCBI US

4114-0.35

11.707.94

3.8820.99

31.915.40

7.846.05

-12.88

22644

JACOBS ENGINEERING GROUP INCJEC US

6486-4.57

16.256.21

3.397.79

10.895.06

16.5310.06

11.809.18

18807

AMEC FOSTER WHEELER-SPN ADRAMFW US

240236.61

12.256.60

2.917.92

14.992.73

7.62-

--

-

TECHNIP SATEC FP

68222.62

13.9812.71

4.769.30

15.993.63

13.874.07

14.98-

18440

AECOMACM US

5336115.27

2.976.26

1.3313.60

11.352.37

10.168.37

5.929.41

40200

FLUOR CORPFLR US

7434-15.87

6.046.32

3.0115.14

19.726.88

15.257.15

11.2310.82

44726

KBR INCKBR US

2101-19.95

6.387.03

4.1014.67

2.825.58

11.614.59

65.8522.59

12333

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Appendix

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