IR - Chart Industries: Marching Higher

2023-06-14 16:59:48 ET

Summary

• Chart Industries, Inc. surprised investors in a bad way with the Howden deal last year.
• The deal was huge, leverage was set to increase a lot, all while end markets were cooling down.
• Fearful about the potential leverage overhang, I was hoping for a quick rebound in the shares.
• Following a solid first quarter, and full year outlook, Chart Industries leverage is coming down amidst a bolt-on divestment being announced here.

Shares of Chart Industries, Inc. ( GTLS ) have come to life a bit again, despite an environment in which energy prices are under pressure. As recently as March, I thought that shares were in a tough place, despite the long-term solid positioning towards the energy transition, as the company announced an expensive, leveraged, and surprising deal for Howden late last year.

Some Background

Chart Industries is a big play on the energy transition, notably LNG. The company has long invested to build up this position in the industry, and the positioning took a long time to show up in the actual sales and earnings results.

With the business reliant on lumpy orders, a $1 billion business a decade ago had only grown in a modest fashion to a $1.32 billion business in 2021. The company posted relatively modest margins, reporting GAAP operating profits of $88 million and net earnings of $59 million, equal to $1.44 per share. That said, adjusted earnings came in at twice that number.

Originally, the company guided for a huge year in 2022, seeing sales up to $1.70-$1.85 billion, the result of the war in Ukraine, and that revenue guidance even excluded the potential for big lumpy LNG orders. With earnings seen between $5.25 and $6.50 per share (on an adjusted basis), a $100 shares rallied to the $200 mark. During 2022, shares rallied to the $240 mark, even as the company trimmed the outlook for 2022 a bit, attributed to the timing of orders. This was made up for by the 2023 guidance, a year in which sales were seen around $2.15 billion, with earnings seen around $8 per share.

At a peak valuation of $240, the 26 million shares valued equity at $8.6 billion, at 5 times sales and 30 times forward earnings, demanding valuations despite the rosy prospects.

This investment thesis was blown out of the window in November 2022, as the company announced a $4.4 billion deal to acquire Howden, a mission-critical air and gas handling products provider whose line-up includes blowers, fans, heaters and steam business. With a $1.8 billion sales and $340 million EBITDA contribution, the deal came in at a huge discount to its own valuation (in terms of valuation multiples), and that is before $175 million in projected synergies, expected to increase to a quarter of a billion dollars over time.

Pro forma net debt would increase to $3.8 billion, equal to about 4.25 times EBITDA. This EBITDA number was a bit high for my taste, in part because it was based on a strong EBITDA performance in the wake of the 2022 energy crisis, which made me fearful about leverage ratios if energy prices were to revert, which was already happening at the time to some extent. Investors voted with their feet, sending shares down almost a hundred dollars to $154 on a single day, shedding some $3.6 billion in value in the process.

While I was fearful of the "diworsifcation" and leverage, the move felt like a huge overreaction, given the cheap acquisition multiples and synergies projected, which made that I initiated a small position at $135 in anticipation of a rebound.

What Happened?

Since the deal announcement shares have traded in a $110-$150 trading range as the actual news flows was concerning to some extent. This started with the sale of 5.9 million shares at just $118 in December. In the meantime, interest rates kept moving higher and energy prices came down, pressuring shares in anticipation of headwinds for the operations.

In February, the company posted 2022 sales at $1.61 billion with adjusted earnings of $4.69 per share coming in a bit short. It was promising to see however that the company maintained the 2023 guidance and has built up a net cash position pre deal closing, although this includes the proceeds of the share issue of course.

The deal closed in March already as execution is needed to avoid a debt overhang, certainly if parts of the business might come under pressure amidst lower energy prices. Given this backdrop, I was waiting for an exit opportunity on rips, given the worsening operating conditions.

What Now?

With shares trading at $115 in March, and me having averaged down a bit, we have seen a solid recovery over the past quarter, with shares now trading near the $140 mark.

This was driven by a recovery in the markets, but some upbeat corporate news as well. First quarter sales rose nearly 52% to $538 million, although that GAAP operating profits only came in at $36 million, with deal-related expenses resulting in some net losses (although adjusted earnings came in at $1.41 per share). Net debt was reported at $3.9 billion, as expected as the company updated the 2023 guidance (reflective of the Howden deal) with sales seen between $3.66 and $3.80 billion, with adjusted EBITDA seen between $780 and $810 million.

On top of the solid start to the year, the company announced a $300 million divestment of its Roots business to Ingersoll Rand ( IR ) , with the activities valued at a low double-digit EBITDA multiple with some $115 million in sales leaving the door. The deal will cut net debt by about a tenth with the company announcing a 2024 EBITDA number around $1.3 billion, which looks quite solid.

Given this, leverage concerns are quickly abating, even if economic concerns and lower energy prices are still a factor. With earnings this year now seen at a midpoint of $6.10 per share (actually below the $8 per share number communicated pre-Howden), the valuation has been de-risked quite a bit. Given the latest recovery, the earnings multiple has increase to the low twenties again as in fact the earnings guidance looks a bit soft.

Given this, I am tempted to take some tiny profits from Chart Industries, Inc. However, on the other hand, leverage concerns are abating, and the company is reiterating the guidance, despite softer energy prices. Hence, I am upping my desired exit levels, hoping for a further momentum driven recovery post $150 before considering exiting the Chart Industries, Inc. stock position.

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