HDSN - Hudson Technologies: Why I'm Cautious About Investing Here

Summary

• Hudson Technologies is poised to benefit from increased environmental regulations as it provides sustainable solutions for commercial and industrial chiller plants and refrigeration systems.
• The company has yielded shareholders a roughly 1000% return since 2020 due to a spike in sales and the shift toward environmentally responsible practices.
• Hudson's leadership position in the refrigerant reclaim market, holding a 35% market share, is a significant advantage.
• Hudson has the opportunity to consolidate market share and boost profitability by acquiring smaller companies amid the fragmented market resulting from environmental regulations.

Introduction

As the world grapples with climate change, governments are increasingly introducing environmental regulations to reduce greenhouse gas emissions. These regulations are disrupting industries and creating opportunities for companies that can adapt to the changing landscape.

Hudson Technologies ( HDSN ) is one company that appears to be poised to capitalize on the increased environmental regulation in its industry. By providing sustainable solutions for commercial and industrial chiller plants and refrigeration systems, Hudson is at the forefront of the shift toward environmentally responsible practices.

Increased regulations have led to a spike and sales and helped to fuel an explosive increase in its share price, having yielded shareholders a roughly 1000% return since 2020.

With a lofty financial goal of reaching a revenue of over $400M and a gross margin of approximately 35% by 2025, Hudson seems to believe they are positioned to continue its growth trajectory.

Within this article, I’ll examine what Hudson does, how they’ve managed to grow, and provide a commentary on where I think shares could go from here compared to peers in its industry.

Environmental Regulation Driving Growth

Hudson Technologies has delivered an incredibly strong financial performance in recent quarters, highlighted by a robust Q3 2022 where revenue grew 48%. A focus on Environmentally sustainable products has likely helped to contribute to this success. As the global community continues to prioritize sustainability, companies like Hudson are poised to benefit from their commitment to environmental responsibility due to regulations that may benefit them.

The regulatory landscape around refrigeration and cooling systems is rapidly evolving, with governments introducing more stringent regulations to promote sustainability. For example, the California Air Resources Board has proposed a requirement that OEMs use a minimum of 10% reclaimed refrigerant on factory-charged equipment. The Environmental Protection Agency (EPA) is expected to follow suit, creating an opportunity for Hudson to assist OEMs in meeting regulatory compliance. As similar requirements are rolled out on a wider scale Hudson may see sales spike even higher.

Additionally, Hudson's leadership position in the refrigerant reclaim market, holding a 35% market share, is a significant advantage in this evolving environment. With an installed base of over 100 million HFC units requiring transition to next-generation equipment, Hudson's reclamation technology and service capabilities are essential for facilitating the transition.

DoD Contract

Hudson Technologies' financial performance has also been bolstered by its contract with the US Department of Defense (DoD), which is expected to provide the company with a significant source of revenue over the next decade. The contract has a maximum value of $400 million over 10 years and provides a stable source of revenue for the company, as the US government is a wealthy client that is likely to continue using its services if Hudson performs well.

The DoD contract is a significant win for Hudson Technologies and provides them with a level of financial stability that many companies in their industry may not have. The US government's tendency to renew contracts with successful service providers is likely to benefit Hudson in the long term. However, it is important to note that Hudson's success on the contract is not guaranteed and they will need to continue to perform well in order to maintain their position as a trusted partner of the DoD.

Mergers and Acquisitions

Hudson Technologies has the opportunity to capitalize on the fragmented market resulting from environmental regulations by acquiring smaller companies to consolidate market share and boost profitability. By leveraging economies of scale and gaining pricing power, Hudson can reduce costs and increase profits, which could deliver significant returns to investors.

As an illustration, Hudson's 2017 acquisition of Airgas-Refrigerants, Inc., its largest ever acquisition, for roughly $220 million, provided the company with various benefits, such as positioning it well in the transition from Hydrochlorofluorocarbons (HCFCs) to Hydrofluorocarbons (HFCs), expanding its customer base, increasing reclamation processing capacity, and providing access to refrigerant for reclamation.

Hudson acquired the company for less than 1x sales showing that the company is focused on acquisitions for the right price, not just any price.

Hudson Technologies Vs Peers

Let’s take a look to see how Hudson performs versus its peers. For this article I’ll be focusing on DXP Enterprises ( DXPE ) Alta Equipment Group ( ALTG ) and Karat Packaging Inc ( KRT ) while these peers are not perfectly comparable they are relatively similar in terms of size in the industrials sector.

Quant Factor Grades

Per Seeking Alpha, Hudson Technologies rates as the best, or tied for the best in all Quant Factor Grade categories. Best in Valuation, Growth, Profitability, Momentum, and EPS revisions, now that is some strong praise! Given its explosive share price and revenue growth, I am unsurprised by the growth and momentum metrics, but let’s dive into the data provided by YCharts to gain more clarity on this story.

Revenue and EPS Growth

As you can see in the chart above, all 4 companies have seen relatively strong revenue and EPS over the past few years. But in terms of EPS, Hudson stands out from the rest of the pack having increased from a negative EPS in 2019 to the highest in its peer group at $2.22 per share.

Hudson’s revenue growth has been volatile from time to time, often spiking for short periods only to crash down to low or no growth shortly after. While 40%+ growth is exciting it’ll be important to see if this level of growth can be sustained or if it’ll crash back to the lower range it’s historically been at.

EBITDA Margins

Hudson stock boasts an EBITDA margin of 44%, the highest of its peer group, having massively grown from prior lows of around -25%! While these margins are strong their historical volatility makes me concerned and raises doubts as to if they will be able to maintain them this time. The track record suggests otherwise, thus warranting some caution.

Return on Invested Capital

At 53% Hudson has been the best capital allocator by far among its peers. What is more troubling though is its long-term track record in deploying capital which is much worse often in the low single digits or even negative for years at a time. Results like this make me question whether management can continue to capitalize on their newfound success or if they are doomed to repeat history. Investors would be wise to pay attention to the next earnings call on March 14th to see how they rounded out the year.

Conclusion

Compared to its peers, Hudson is still the most cheaply priced at just 3.6x EV to EBITDA but given how volatile its performance has been I believe a discount is likely warranted. If their growth can continue at a similar pace they are likely undervalued but if history repeats itself they could also be quite overvalued.

In conclusion, Hudson Technologies is a company that appears to be well-positioned to capitalize on the increased environmental regulation in its industry. Its leadership position in the refrigerant reclaim market, and its contract with the US Department of Defense are all significant advantages for the company. Additionally, Hudson has the opportunity to further consolidate and boost market share through M&A.

Overall, I am neutral on the shares due to the high potential for growth paired with my concerns about their ability to execute over the long term.

I rate Hudson Technologies a Hold.

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