GTLS - Chart Industries: High Price To Earnings Ratio Weakness

2023-04-27 11:01:12 ET

Summary

• This high-flier got pummeled for disappointing guidance.
• The first quarter is traditionally the weakest for Chart Industries, Inc.
• Mr. Market did not want conservative guidance. Instead, he wanted gung-ho guidance that would be met.
• The current bank crisis argues for an order slowdown that will likely be made up when current issues pass.
• Long-term lead times combined with some fairly large projects and customers make for an unusually firm order backlog for Chart Industries.

When a company like Chart Industries, Inc. ( GTLS ) has a high price-to-earnings (P/E) ratio, then the market will take any disappointment as a sign of things to come. This is true even if the market got it wrong, to begin with. What may further some downward volatility is the financing of the latest acquisition of Howden that the market clearly did not like, combined with the "conservative" guidance noted before. Then there is the fact that the first quarter is traditionally the company's weakest quarter, even if some orders moved into that quarter from the previous quarter.

Never mind that the company has a very firm backlog, as does the acquisition. Both companies go after major projects that tend to progress even during a time like the current when there are all kinds of fears about the banking sector. For Chart, the acquisition marks continued movement away from the cyclical oil and gas market while moving into the counter-cyclical aftermarket. This combined with the continued penetration of some "hot" markets will hopefully make earnings less cyclical going forward.

Guidance

The Chart Industries, Inc. stock price appears to not like the guidance after it did not like the financing that went along with the acquisition announcement. But the firm backlog of both companies provides a reliable minimal cash flow if no sales were made beginning tomorrow. That should allow the market to recover some confidence in the whole situation going forward.

Management claims to have picked the middle ground for this guidance. Obviously, Mr. Market was hoping for better. That makes little to no common sense when there is a banking panic going on. Now is the time to be prudent rather than hopelessly optimistic. If and when market conditions change, then management is in a position to change with those conditions (when they hopefully improve from the current panic situation).

Investors need to remember that the first two quarters are probably fixed at this point for management due to the long lead times many of these products have. Minor changes may be possible now for (maybe) the second and third quarters. That provides a level of certainty that this now highly leveraged company has.

Management did mention that the financing that was placed before the merger enabled the company to pay for this merger with cash and debt. Therefore, no preferred stock was issued at the time of the close. While that may lessen dilution, it will raise leverage fears.

This will make it imperative that the deleveraging of the company proceed at least as fast as guided. One thing about debt is that debt counts right away in many leverage calculations, whereas the acquisition takes a year to fully be included in the calculation. Many lenders will allow some variation of the calculation when calculating these ratios to take into account the full earnings power of the acquisition. We will see what Mr. Market thinks about this as the post-acquisition period proceeds.

Post Acquisition Benefits

One of the things about conservative guidance is that the market expectations remain low. That gives management a chance (or a better chance) to beat expectations, which can start the stock price "comeback" after what happened here.

This stock has generally traded on the pace of orders and the state of the company backlog. Therefore, the ability of management to position itself for positive news is a great "just in case" strategy for when a backfire happens that pummels the stock.

In this case, management can point to record orders. Since earnings for the current year will likely only change in minor amounts, the record order intake and backlog point to a better-than-expected fiscal year 2024. That means that deleveraging may happen faster than the market expects.

In the meantime, management also updated on some synergies and other interesting topics having to do with the now-completed acquisition. Any deleveraging process has a critical first few months to first year, when debt repayments from the originally high level are extremely important. That is the case here. So, the market will be watching closely for any possible "detours."

EBITDA Progress

In the meantime, this original plan does not appear to have yet changed materially. The latest presentation appears focused upon the initial steps taken after the acquisition and some of the progress already apparent. A long-term forecast like this is unlikely to be materially different just yet.

One of the things to remember about guidance is the fairly long lead times. It should therefore be no surprise that many sales going into the backlog will be delivered in the next calendar year. Management likely has a good view of what next year is looking like already.

The other key idea is that most Chart acquisitions are made to provide the customer with a greater selection of products from the same seller. This is kind of a "one-stop-shop" for the markets chosen, and that "one-stop" keeps growing to serve ever larger market demands through the long history of company acquisitions. There is unlikely to be a lot of sales benefitting the current fiscal year because of the long lead times. But the next fiscal year is another story entirely. Management clearly has a lot of hope (as shown above) for considerable sales growth based upon this acquisition.

The way an acquisition usually works is for Chart management to hang onto as many people as possible (even the owners). The acquired company then can function as independent on the manufacturing side. Sales efforts are then combined as needed for the "one-stop shop." If all goes well, the combination results in additional sales opportunities that the separate entities had no chance for.

As shown above, the purpose long-term is to smooth out earnings. Chart already deals with governments a lot and has a lot of rapidly growing markets to sell to. However, at some point, those markets mature and therefore will likely become business cycle sensitive. Hence, the emphasis on the aftermarket, service and repair.

Obviously, customers love it when they can call up the seller for aftermarket issues. It may also be a chance for more sales. Similarly, long-term arrangements are "sticky." Those customers are far less likely to pick up and leave.

Weaknesses

Management can become too complacent with long-term arrangements. That will nullify the advantages of such arrangements. It can result in a sudden large noticeable loss of competitiveness that the market will notice.

Any diversification means that management has to make sure that all the parts "pull their weight" in terms of profitability. So many managements are not detail-oriented enough or lack experience with the business of the new acquisitions.

A large acquisition is usually a "cannot fail" acquisition, which is very different from the typical acquisition this company makes. The relatively high financial leverage until this succeeds is yet another risk. Offsetting this is management's experience with a lot of acquisitions over its history.

Last, this management acquires new products through acquisitions. The challenge will be to keep those new products coming while deleveraging.

The Future

Chart Industries, Inc.'s management has a presence in a lot of hot markets that should keep the growth trajectory going for some time. The challenge remains to continue to grow rapidly while maintaining quality and margins (and staying in tune with the market in general). That will become more difficult over time. Therefore, eventually, growth per share will slow. Right now, that appears to be a long way off. But that perception can change at any time.

The revaluation that would occur with growth slowing is a risk with highfliers like Chart Industries, Inc. stock.

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