2023-04-06 02:30:54 ET
Summary
- Continued pricing realization and a favorable mix would help ChampionX achieve the EBITDA margin target.
- However, exit from certain RCT product lines reduced its Reservoir Chemical Technologies segment topline.
- Higher free cash flow allowed it to improve net debt-to-adjusted EBITDA by Q4 2022.
- In February, it increased dividend by 13% to increase shareholders' returns.
CHX Presents An Opportunity
I discussed about ChampionX Corporation ( CHX ) in detail in my previous article . On the face of it, ChampionX Corporation did not have a great quarter in Q4 as sales fell in all operating segments in varying degrees. Despite that, the company remains optimistic about strengthening its financial position in the coming quarters because of its robust strategies. It aims to improve its FCF-to-EBITDA ratio sharply, which means the company can pursue a capital-light portfolio of businesses. It has already been proved that the synergies from the Ecolab merger impacted its margin and expanded its artificial lift and chemical businesses. Its potential opportunities grew significantly in 2022, particularly in North America.
However, in late-2022, lower cross-supply sales to Ecolab causes damage to its topline. Backed by robust liquidity, it plans to raise shareholders' returns through dividend hikes and share repurchases. It plans to increase investment in the digital and emissions platform for long-term growth. CHX stock is relatively undervalued versus its peers. Investors might consider "buying" it at this level for short-term gains.
Looking Back At The Acquisition
Before we delve into ChampionX Corporation's current strategic goals and performance, let us first discuss the pivotal event that changed the company's growth direction. As I discussed in the previous article, the company's Production Chemicals' business growth benefited from the Ecolab merger in late-2020. The chemical business was boosted when it acquired Ecolab's upstream energy business, which expanded its artificial lift and chemical businesses.
On top of it, the adoption of its modular fit-for-purpose technologies has accelerated among the operators. Improved productivity in the Chemical Technologies and Artificial Lift businesses expanded the operating margin in 2022. However, in late-2022, lower cross-supply sales to Ecolab pulled down the Reservoir Chemical-related sales in the near term.
Key Strategies
The key strategy decision for CHX was its continuation in pricing realization and achieving a favorable mix. The company's management is confident of achieving the near-term goal of raising the EBITDA margin to at least 20% from the current 18%-level. The positive outcome of CHX's strategies manifested in improved adjusted EBITDA margin (by 120 basis points) in Q4 compared to Q3 despite the typical seasonal slowdown. Higher EBITDA also led to higher free cash flow. In FY2022, it generated a free cash flow of $329 million. A high percentage of FCF-to-EBITDA means the company can pursue a capital-light portfolio of businesses. It plans to generate 50% to 60% of free cash flow to EBITDA conversion.
As a corollary, the third leg of its strategy involves increasing the shareholders' returns. In Q4, it paid a cash dividend of $15 million and $80 million in share repurchases. Combined, it repaid 56% of the FCF generated to shareholders. It targets to increase the return rate to 60%.
CHX has been generating ample new customer wins for the past couple of years. In FY2022, it generated $45 million of new customer wins – 50% higher than the previous year. Approximately 74% of this came from North America. According to the company's estimates, the total pipeline of identified potential opportunities has grown by 47%.
Q1 2023 FY2023 Outlook
In Q1 2023, CHX's management expects revenues to increase by 12% (at the guidance mid-point) compared to a year ago, but a marginal decrease from Q4 2022. A North American onshore business recovery, particularly in Drilling Technologies, can push growth, despite the seasonal declines in chemical sales.
In Q1 2023, the management expects to record a 3% lower EBITDA growth. It plans to increase investment in the digital and emissions platform, which would lower EBITDA in Q1. Nonetheless, it would represent a healthy 300 basis point improvement over the previous year.
By 2023, the management expects the EBITDA margin to improve gradually, exiting the year with a 20% EBITDA margin, or 200 basis points higher than FY2022.
Understanding The Industry Dynamics
In Q1, there is uncertainty over the direction of the industry indicators. From February 2022 to February 2023, the drilled and completed well count was higher (25% and 25% up, respectively), while the drilled but uncompleted (or DUC) wells declined by 7%. During this period, the active frac spread count increased by 8%, according to Primary Vision's estimates.
Segments: Performance And Outlook
During Q4, CHX's Production Chemical Technologies segment revenues decreased marginally by 1% compared to Q3. However, the EBITDA margin (adjusted) expanded due to volume growth and selling price increases.
In the Production and Automation Technologies segment, revenues decreased by 1.4% in Q4 versus Q3. However, demand for digital services improved because customers focused on implementing digital technologies to reduce emissions and gain cost efficiency. So, revenues will likely increase in the coming quarters in this segment.
The Reservoir Chemical Technologies segment saw the weakest performance for two consecutive quarters in Q4 (27.6% revenue fall) compared to Q3. Exiting certain RCT product lines and the seasonal industry activity slowdown resulted in a revenue decline. The EBITDA margin, however, improved.
Cash Flows, Dividend, And Debt
In FY2022, CHX's cash flow from operations increased, led by higher revenues in the past year. Free cash flows (or FCF) also improved in FY2022. In February, it increased its quarterly dividend by 13% to return excess capital to shareholders.
CHX's debt-to-equity ratio was 0.37x as of December 31, 2022, while the net debt-to-adjusted EBITDA improved to 0.6x from 0.8x in the previous quarter. It had $889 million in liquidity as of that date. Its liquidity increased by $78 million while it repaid $20 million in debt during the quarter.
CHX's forward dividend yield is 1.07%, similar to its peer, Cactus's ( WHD ) dividend yield of 1.04%.
What Does The Relative Valuation Tell Us?
CHX's forward EV-to-EBITDA multiple contraction versus the adjusted EV/EBITDA is steeper than its peers because its EBITDA is expected to rise more sharply than its peers in the next year. This should typically result in a higher EV/EBITDA multiple than peers. The company's EV/EBITDA multiple (9.9x) is lower than its peers' (WHD, [[FTI]], and [[FTK]]) average. So, the stock is undervalued at this level compared to its peers.
Analyst Target Price And Rating
According to data provided by Seeking Alpha, seven analysts rated CHX stock a "buy" in the past 90 days (including "Strong Buy"), while three recommended a "hold." None of the sell-side analysts rated it a "sell." The consensus target price is $35.3, which yields ~24% returns at the current price.
What's The Take On CHX?
Since late-20202, CHX's chemical business was boosted when it acquired Ecolab's upstream energy business, expanding its artificial lift. The revenue and cost synergies from the merger will also aid in the bottom-line gains in the near term. Continued pricing traction and a favorable mix would help the company achieve the 20% EBITDA margin goal in the near-to-medium term. At the start of 2023, its revenue visibility looks strong with a substantial addition of new customers. So, the VanEck Vectors Oil Services ETF ( OIH ) outperformed the stock in the past year.
However, exit from certain product lines resulted in continued revenue loss for its Reservoir Chemical Technologies segment. As cash flows improved, it continued to reduce debt and focused on shareholders' returns. I expect the stock to produce gains in the short-to-medium term.
For further details see:
Customer Wins And Cash Flow Improvement Likely To Turn Around ChampionX