HDSN - Hudson Technologies: A Bright Future Ahead In A Strong Industry

Summary

• Hudson Technologies is a market-leading company in the refrigeration industry, with strong financials and a solid balance sheet.
• HDSN stock has outperformed all of its peers in terms of LTM EBIT margin, LTM gross margin, and LTM net income margin.
• The company's strengths outweigh the risks and make it a compelling investment opportunity, with a target exit return of 20%+, per my calculations.

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Hudson Technologies ( HDSN ) is a company that operates in the refrigeration industry, which is often considered to be recession-proof due to the essential nature of its products and services. In the last four years, the company's EBIT has increased more than 3x, and it is outperforming all its peers in terms of LTM EBIT margin, LTM gross margin, and LTM net income margin. These strong financials, coupled with a Weighted Average Cost of Capital ((WACC)) of 8.31% and a Discounted Cash Flow ((DCF)) analysis indicating 23% upside potential, suggest that HDSN is a company with a bright future.

Company Background

Hudson Technologies operates in three main business segments: refrigerant services, which includes the reclamation and sales of refrigerants; refrigeration services, which provides maintenance and repair services for refrigeration systems; and industrial fluids, which includes the reclamation and sales of industrial fluids. The company's products and services are used in a variety of industries, including air conditioning, refrigeration, and industrial manufacturing. Hudson Technologies is known for its commitment to sustainability and has implemented several initiatives to reduce its environmental impact, such as its refrigerant reclamation program. Despite being around for 30+ years, HDSN is the youngest of its competitors. More importantly, HDSN has been outperforming all of its peers in a multitude of operating statistics and has continued to outperform the market.

Financials

Looking at the Income Statement, HDSN's revenue has grown consistently since 2020. The company's revenue in 2020 was 147.6 million and in 2021 it increased to 192.7 million, and in the most recent quarter (9/30/2022) revenue was 89.5 million. The YoY revenue growth over the past two years has been 30.9%.

Furthermore, HDSN's cost of sales as a percent of revenue has decreased substantially in recent years. In 2018, the cost of sales as a percent of revenue was 104%, indicating it cost of sales was almost equal to the revenue. But the company was able to bring it down to 89% in 2019, 76% in 2020, 63% in 2021 and reaching 51% in most recent quarter of 2022. This significant decrease in the cost of sales as a percentage of revenue over the years indicate that the company's cost control measures have been effective and it is able to maintain a lower cost structure while expanding its revenue, potentially leading to increased profitability. This cost of sales decreasing trend is a positive sign for company's future growth.

As you can see in the image above, HDSN has a growing balance sheet. The company's current assets have increased significantly over the past two years, with 2020 current assets at 62.1, 2021 current assets at 119.9, and in recent quarter (9/30/2022) current assets at 192.6. The growth in current assets suggests that the company has been successful in generating positive cash flow from its operations, and it is able to meet its short-term financial obligations. Furthermore, HDSN's total assets have also increased over the past two years. In 2020, the company's total assets were 161.6, which increased to 215.7 in 2021 and reached 286.6 in recent quarter (9/30/2022). This indicate HDSN has been successful in acquiring assets such as property and equipment, investments, and other long-term assets to help fund its growth.

On the other hand, the company's total liabilities have fluctuated over the years. In 2018, the company's total liabilities were at 159.1, decreasing to 135 in 2019, 121 in 2020 and increased to 144.8 in 2021, but again decreased in recent quarter (9/30/2022) to 116. This fluctuation in liabilities is showing company's ability to manage its debt effectively. It also gives an indication that the company has enough assets to cover its liabilities.

Hudson Technologies - Valuation

WACC

For some background information, weighted average cost of capital is a measure of a company's cost of capital, which is the required rate of return that investors expect to receive for providing capital to the company. It is calculated by considering the company's cost of equity and the cost of debt and weighting them based on their relative proportions in the company's capital structure. A lower WACC indicates that a company has a lower cost of capital, which can be a positive sign for investors. Using data provided by S&P Capital IQ, I am able to calculate a WACC of 8.31%, whereas the average cost of capital in the Specialty Chemicals Industry is 11.47%, per NYU Stern .

Intrinsic Value

Using this information, I constructed a Discounted Cash Flow ((DCF)) analysis. DCF is a method used to find the intrinsic value of a company based on the present value of its future cash flows. It involves forecasting a company's future cash flows, discounting them back to their present value using the WACC, and then subtracting the company's current liabilities to arrive at a valuation. A DCF analysis that indicates a high upside potential suggests that a company's future cash flows are expected to be higher than its current valuation, making it a potentially attractive investment opportunity. Per my analysis, as can be seen below, Hudson’s free cash flow is projected to hit nearly $100 million in the next few years along with an implied share price of $12.15.

Competition

One of Hudson's key strengths is its strong financial performance, with it dominating competitors when it comes to operating statistics. The company's LTM EBIT margin of 42.4% is well above the average of its direct competitors (4.87%) and its LTM gross margin of 52.2% is also significantly higher than its competition (21.2%). These strong margins have allowed HDSN to generate a net income margin of 33.3%, which is again higher than its direct competition of 3.7%. Hudson's closest competitor, when it comes to operating statistics, is Watsco, Inc. ( WSO ). Watsco still falls short of Hudson in these four categories but has a respectable 27.9% LTM Gross Margin as well as both EBIT and EBITDA margins over 11%. Some other notable competitors include Transcat, Inc. ( TRNS ), CCOM Group, and NOW Inc. ( DNOW ), which also come up short of Hudson.

Additionally, HDSN has a solid balance sheet and a modest debt-to-equity ratio of 0.36. Given its high growth and low debt, HDSN also has several opportunities for future growth. One opportunity is the potential to expand into new markets, either through organic growth or through strategic acquisitions. The company could also potentially capitalize on any shifts in consumer preferences towards more energy-efficient products.

Potential Risks

There are potential risks to consider when investing in HDSN. One short-term risk is the potential for increased competition in the refrigeration industry. While the industry is generally considered to be recession-proof, there is always the possibility that younger companies could emerge and disrupt the market. Although HDSN has been outperforming the market recently, market conditions have been generally unfavorable and can result in some uncertainty in the future.

Final Thoughts

Overall, HDSN is a company with a strong financial performance, solid balance sheet, and several opportunities for future growth. While there are always risks to consider when investing in any company, I believe that HDSN's strengths outweigh these risks and make it a compelling investment opportunity. With a WACC of 8.31% and a DCF-derived upside potential of 23%, I have a target exit price of $12.15 for the company.

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