GTLS - Chart Industries: Here Goes Everything

2023-03-09 10:04:11 ET

Summary

• The Howden acquisition will be the largest in company history.
• The logistics of a large acquisition can be daunting.
• Management will minimize risk by allowing Howden to operate as it has in the past while combining sales efforts for future benefits.
• Chart Industries has long grown through acquisitions. The acquisition experiences will be tested with this large acquisition.
• Management cannot afford any negative results until deleveraging is well underway. This includes external events that are not controllable by management.

(Note: This article was in the newsletter on February 26, 2023.)

Chart Industries ( GTLS ) is about to embark on easily the largest challenge in the company history. The company had a long history of small to maybe medium acquisitions that have greatly enlarged the company product line. Management has long minimized integration risk by allowing the manufacturing part of the merger to run as it was before the merger. Generally, the benefits came from a combined sales effort even though the new subsidiary could sell products as it did before. Small and even medium sized integrations are generally far less risky and have a high chance of success. A failure is not a company killer.

But managements with a long track record of success often go for even greater challenges. In this case, the coming closing of the Howden acquisition is a "here goes everything" challenge where it had better succeed and nothing unforeseen that is unfavorable had better happen during the deleveraging process because this company is going to be very leveraged.

The finances alone make this a very speculative situation.

Now, management has kind of been mitigating the leverage risk by noting that the business has long lead times (and both companies have an impressive and rapidly growing backlog). But that first-year leverage points to a fair amount of corporate risk. Also adding to that financial risk is the fact that Howden is a far larger acquisition relative to the size of Chart than was ever the case before.

Therefore, integration and combined sales efforts have to succeed after the acquisition closes. Failure is not an option this time. The benefits of the combined sales effort also must be realized as management plans at least some combined company growth in addition to debt repayments to reduce those ratios as shown above.

Mitigating this is the fact that management has about 60% of the current backlog scheduled for sales. Generally, the backlog as stated for Chart is firm. But sales can move to another quarter because some of the large projects that these products go to can have delays or change of plans. Material cancellations are rare (if they ever happened at all).

Most of the time, about six months of sales and earnings are firm and cannot change. The next six months generally can be altered by incoming small to relatively medium sized orders. Howden, supposedly operates the same way and also has a robust and rapidly growing backlog.

The rating on the debt clearly presumes a certain amount of success. That would be based upon management performance with acquisitions that have occurred throughout the company history.

Rapid growth and large acquisitions run the risk of loss of cost control and quality control. This management is going to have to be "laser focused" to bring this off successfully. I like the chances of management succeeding. But an unexpected unfavorable event that hurts business prospects could be very damaging to the outcome of this merger if it happens in the first two years.

Combined Business

Generally, Chart expands the product line and sales opportunities by acquiring businesses. One of the "small print" items is that there will be no acquisitions during the deleveraging period. This does run the risk of the company losing its competitive edge. But in the meantime, this merger opens up a lot of opportunity (particularly in the aftermarket and repair business that tends to be countercyclical).

Chart and Howden do not really compete directly (for the most part). Instead, both companies offer solutions to different parts of major projects going on in the world. A combined company offers "one stop shopping" and is therefore favored over a lot of small companies. It is considered a competitive advantage.

Chart has long grown rapidly (and accretively on a per share basis) by such acquisitions. Mr. Market has generally loved the strategy to make the stock a market darling many times in the past because Mr. Market loves rapid growth.

One of the ways a current (speculative) investment can succeed is the deleveraging process combined with continued rapid growth resulting in the stock returning to market favor. The stock has rarely had as low a price-earnings ratio as it does now. However, the leverage also has never been as great as it is now.

Many of the markets served are rapidly growing markets. New products to service those rapidly growing markets also come out at a rapid pace. In the immediate future, the combined company is likely to be a very formidable competitor in a very fragmented market. As can be seen from the above chart, there are a lot of companies that in the past have served a small part of the market where Chart competes. Given the fast growth of these industries, the market is likely to remain fragmented for some time to come.

The Future

Chart Industries began (many decades ago when I was a lot younger) as a company that depended upon large natural gas projects for business. That was a very cyclical business. Through acquisitions, the company has acquired businesses (like aftermarket) that are countercyclical and less dependent upon the oil and gas industry. For as long as I can remember, the food subsidiary existed as well as some others. But sales to oil and gas dominated the business for a long time.

Now it looks like clean energy will dominate the future. Orders from large oil and gas projects will be "extra". Management is also working hard (as the Howden merger demonstrates) to minimize the effects of a typical business cycle. The future earnings of the company are likely to be less cyclical than was the case in the past.

Some divisions, like the clean water division, may not have a business cycle at all. That division has a large government influence. Others, like the rapidly growing hydrogen market, are likely to become sensitive to the business cycle eventually as the market matures.

For the time being, this company appears to have a lot of rapid growth ahead. The management has an excellent record of growing by acquisitions. That experience will be put to the test with the closing of Howden because Howden is so large relative to the size of Chart. Both companies are relatively big which can imply some logistical challenges that do not exist with smaller acquisitions.

Nonetheless, I like the chances of management succeeding. But a worst-case scenario could involve the loss of a significant amount of the original investment. That makes the whole investment proposal speculative. Risk averse investors can look elsewhere. This investment will need a fair amount of monitoring. Additionally, Chart Industries' common stock is usually volatile. The leverage could well make the stock more volatile.

Last (but not least) the margin on the various products varies widely. This company can have significant margin variance from quarter to quarter (and definitely has in the past) without any negative meaning (other than the worrying of Mr. Market). For all these reasons, it is best to keep the position relatively small so you can sleep at night.

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