GTLS - Chart Industries: Deleveraging In Style

2023-04-12 11:23:38 ET

Summary

• The high leverage of this transaction clearly worried the market.
• Record setting orders could offset some market concerns.
• This fiscal year results are largely "set in stone" due to long lead times.
• Fiscal year 2024 guidance could be raised if the record-setting order pace continues.
• This management has long handled acquisitions and fast growth to produce darn good results.

(Note: This article was in the newsletter on April 11, 2023.)

Chart Industries ( GTLS ) stock has demonstrated that Mr. Market has been worried about the latest merger for some time. Therefore, it is just excellent news when management posted about the backlog situation as of the end of the first quarter. This stock has often traded with a heavy emphasis on backlog information because Mr. Market has a fair amount of current valuation based upon the future outlook. Here, business could not be better, and that great outlook was never more needed to reassure a very nervous market.

The most critical time for any deleveraging strategy is the first few months. Any unplanned upsets or setbacks can be fatal in the first few months. That will slowly decline to damaging as the deleveraging proceeds; and will continue to decline to normal still further along. In this case, management appears to be sending a strong signal to the market that things are going better than expected.

Usually, Chart management does not do a lot of operational combinations. There may be some shutdowns of excess capacity. But generally, the benefits come from the combined sales opportunities. Chart aims to be a one-stop shop and this latest combination was a huge step in that direction at the cost of a leveraged balance sheet.

The combined orders were $740 million in the latest press release. This likely reflects both companies on a standalone basis with their orders combined. The reason for stating that is because Chart really did not acquire Howden until near the end of the first quarter. Therefore, there really was not a lot of time for a combined sales effort.

The first quarter should show more of that combined effort to sell a "one stop shop".

This small view gives the investors a glimpse as to how the company intends to run the combined effort. There are many more examples of this throughout the presentation. The main idea behind the examples above is how one company can now service a greater variety of customer needs and therefore increase the "stickiness" of customer relationships.

Any diversification always has the risk of management "taking their eyes off the ball" especially the cost controls so that part of the diversification no longer pulls its weight.

In addition, the fast growth exhibited here always has a risk of loss of quality control and cost control to turn profits to losses. But this risk is minimized by allowing acquisitions to largely continue to run themselves while combining the sales effort. The result is a long history of very successful acquisitions in place of a research and development effort.

Another key risk reduction is that most of 2023 sales was in the backlog by the end of fiscal year 2022. When one realizes that this combination did not close until March of 2023, then it becomes obvious that 2023 is largely fixed except for some small orders. Therefore, the deleveraging plan that was originally proposed has become very firm for the first fiscal year.

The record pace of orders that the company is now trumpeting means that fiscal year 2024 is off to a good start. As long as that future keeps in front of the current date, then this deleveraging project could proceed with amazing smoothness. One thing that Chart demonstrated in fiscal year 2020 was that the backlog remained even as the market had its doubts.

There were some orders that routinely got switched to a later quarter because large projects inevitably run into delays at some point. But management never lost a significant sale. That is an important point to consider if recession fears that some have actually materialize.

Now what can happen is a failure or delay to approve more large projects that would result in a future lean year or two. However, business has been great for the company ever since the coronavirus challenges have faded. That appears to be the result of management's attempts to diversify into different markets to offset the original cyclical nature of oil and gas that was the "bread and butter" of this company ever since I began following them something like 40 years ago.

Management has clearly so far accomplished what they set out to do. The fiscal year 2023 EBITDA figure is likely to be firm as the backlog for the rest of the year is highly unlikely to change significantly. About the only thing that can happen is some orders may shift from the fourth quarter to the first quarter of the next fiscal year. There may also be room for some small orders still. But as discussed before, sales are not lost from the backlog. That kind of history can be very comforting in the early days of a deleveraging strategy.

Now the continuing record backlogs could well mean that the fiscal year 2024 EBITDA could be revised upward somewhat by the end of the current fiscal year. A lot depends upon the continuing pace of orders received by quarter. This is really where management can speed the deleveraging process.

The divestitures, when announced as completed, may well aid the stock price because the debt repayments resulting from those divestitures will decrease the debt leverage ratio.

The weighted average of the debt, despite the initially high leverage ratio, is a tribute to the management record of successfully integrating acquisitions of the past. Clearly the debt market has attached some risk to the transaction. But there is not as much risk as might be expected given the relative size of the acquisition compared to Chart.

The other thing is that management used less preferred stock than expected. Clearly, this management planned for contingencies to make sure that the financing arrangements completed. The result of the planning is that more debt (no bridge financing) was used and proportionately less preferred stock (and more common stock because management did not plan on issuing common stock originally at all). But overall, the whole transaction came off as planned.

Now management does have to control costs, maintain margins and quality control while growing rapidly. But this management has been doing this for a very long time. Therefore, despite the logarithmic challenges of growing a large company fast, this management clearly has the history to claim enough experience to bringing this project off successfully. The result of that could be a far higher stock price in the future.

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