Clearly Mr. Market did not expect the latest results from Chart Industries (NYSE:GTLS) as shown by the reaction to the fourth quarter report. Shown below is the reaction of the market to the earnings report.
The market has never understood that this management has a backlog that generally requires long lead times. Therefore, potential sales are known quite a bit ahead of time (and so are highly probable sales). Management several times announced in the fiscal year that they were reiterating guidance. As the stock price chart above shows, the market just as often ignored those reiterations. Now Mr. Market acts surprised when management reports the results it actually guided for several times.
This has been a repeating pattern with the market. It gives investors a chance to purchase a bargain as this company rarely trades at 10 times forward projected earnings. Yet management has guided to that projection. Since this management has a very high chance of “hitting that target” or something close to that, one would think the market would pay attention. But a lot of worries dominated the market’s attention instead.
Since the day of that earnings announcement, it is notable that the stock has largely held those gains. Normally the first quarter is the weakest due to low activity levels after the “end of the year rush”. Whether that pattern changes is an open question. But there have been comments by management and others outside the company that lead me to believe each quarter will have larger earnings as the year unfolds for the current fiscal year. That could mean that this stock still has considerable upside potential from the current price.
So, let’s review those worries and see where things stand now.
Debt
This market has not liked high debt levels for some time. The pandemic has put an end to leveraged buyouts for the time being. In oil and gas related issues, the whole period from 2015 to 2020 was so challenging that the market demands very conservative balance sheets. That meant that the debt laden Howell acquisition proposal was not well received by the market and continued to limit stock price appreciation throughout the year.
The market can be pretty stubborn about debt levels as shown by the stock price action throughout the year. Management announced record order levels throughout the year (one way or another) for the combined company while posting the guided earnings that showed good progress, yet it would appear that the debt ratio cancelled all of that out.
Now, management intends to attack that year-end debt level both with payments and by increasing the EBTIDA portion of the debt ratio calculation. It would appear that a 30% improvement on the debt ratio is more than reasonable just from the EBITDA projected growth alone.
It would also appear that the market cares a lot about the debt ratio heading below 3.0 from the stock price reaction. The target in the bottom right hand corner of the slide appears to be a very reasonable goal for the current fiscal year.
Not really noted in the discussion is more than $200 million of convertible debt that will mature in November 2024. The settlement of those notes before the end of the fiscal year could potentially give the debt ratio a positive boost as well. Most likely we will see the results of the election of the holders of this debt in the third and fourth quarters.
United States LNG Project Pauses
This is something that management addressed on the recent conference call:
“In energy markets, we are seeing moderating North American demand, which is offset by increasing international inbound since the beginning of the year. The global market for LNG continues unabated. As the United States pauses, the rest of the world accelerates. This is evident in our commercial pipelines for Big LNG and small scale and floating LNG, which can be seen in the appendix on Slide 28”
“So, what I would say is that since the announcement of the LNG export moratorium that we have seen a meaningful increase in international inbounds. I would say that that didn’t actually mitigate anything on the domestic side, although we’re saying demand moderating because of the uncertainty around the timing of the pause in the analysis. So let me — I’ve addressed the international piece. Let me talk about the domestic piece of the pipeline there. First of all, you’ve heard the extension of Tellurian’s permit to 2029. Cheniere last week discussed that they didn’t anticipate trains 8 and 9 be impacted by the LNG moratorium. And then, you go into the international side where Woodside just recently said they expect a 53% increase in global LNG demand in the next decade. Shell just put their LNG outlook out with continuing growth into the 2040s with the specificity that that was expected in APAC. So, I think on balance the U.S. pause timing uncertainty doesn’t necessarily change our outlook for domestic in the medium term, but the international inbound since late January have given us confidence that that pipeline is going to continue the way we had seen it prior to the pause.”
These are quotes from Chart Industries CEO Jill Evanko during the fourth quarter 2023 earnings conference call. Basically, the answer emphasizes that Chart has the whole world where it can compete for contracts. The United States is only one country in that world. So at least for the time being, the overall business is expected to grow.
But the additional point was made that Chart goes after existing business. There is plenty of that in the United States even if demand is moderating somewhat in the short-term. So far, the total effect is insignificant to the company despite market perceived issues. The company has diversified in recent years so that other divisions can “pick up the slack” if indeed that is needed.
Backlog
When Chart combines the two companies for a “like” comparison of order intake before and after the combination, the major concern is that for much of the history there was really no order growth until recently.
Management has been raising expectations by announcing orders. For example a green hydrogen project out of California was recently announced.
This is where the proposed synergies come into play. That fourth quarter growth is important as is the reason for that growth. The stock often trades based upon backlog progress. As a relatively high price-earnings ratio stock, the price can be extremely volatile based upon backlog progress (or lack thereof).
This has always been where the company has placed the majority of future benefits from an acquisition. Generally, the sales combination benefit is the biggest advantage (and the reason) of an acquisition. Management has been giving examples throughout the year. But there needs to be a lot of these in the future. That could change, but the sales combination strategy clearly adds some safety to management guidance.
It is very reasonable to give management some time to assimilate and optimize the acquisition. Normally production and prior management remain untouched (or at least relatively unchanged). The largest change is sales strategy synergies. That can happen relatively quickly.
This stock tends to trade on order activity for future years as the current year is unusually “fixed” compared to many companies I follow, by a long-lead time. Now management has noted that projects are getting bigger. Therefore, order deliveries also depend upon the progress these projects have made compared to the estimates the company has been given at the time of the order. Delays will push orders into future quarters. But sales are rarely lost. That was true even during an extreme time like the pandemic.
Segment Results
Chart Industries has a long history of successful acquisitions. Howden was larger than most acquisitions, but management has a lot of experience that helps to mitigate typical acquisition risks. The segment results appear to confirm that things are going as planned.
One of the reasons for the Howden acquisition was that Howden had higher margins than many Chart products. Another reason was that the repair business of Howden would help to minimize the seasonality pattern of Chart earnings.
Management has also announced periodic cost cutting moves over the last several years that I have covered. Between that and the Howden products, the corporate profit margin is moving up.
One of the risks in this area is that technology moves very fast. Management constantly reminds investors that there is a significant engineering input into many of the products and bids. There is always a risk that the company falls behind in technology which would decrease margins in the future.
Main Ideas
The acquisition of Howden is off to a good start and the debt ratio is now approaching market accepted levels.
The backlog can only climb at this point if orders come in at a higher level than sales. The sales level increased throughout the fiscal year as the integration of the acquisition progressed. Mr. Market is going to be watching closely for progress in this area.
That means that orders need to resume the steady upward climb that the company has been known for. Now Chart has had a lot of success in the past raising the order rate of a post-combined company compared to when the companies were separate. The challenge this time around will be the sheer size of the acquisition. That will take far more coordination than was usually the case in the past for generally much smaller acquisitions.
Management appears to be tackling the post combination benefits by issuing the above guidance. Note that this company probably knows with great certainty the first two quarters of the fiscal year. At this point the range of variance is likely small due to the long lead times of a lot of the products. The second half of the fiscal year has the possibility of greater variance. That second half is probably largely responsible for the ranges shown above.
Management did reduce guidance on earnings per share from my last few articles. But that guidance is still well above what many analysts were expecting. Most likely as the earnings are reported the market will continue to react positively to the news throughout the fiscal year. There is really not a bad part of the guidance range given because it is a big jump from the current fiscal year.
The achievement of the goals shown above also means that the debt ratio will drop significantly throughout the fiscal year just by expanding the business. Any convertible debt removal should be a plus in a couple of ways. Any money payments towards the outstanding debt balance will likely cause the company to achieve its debt ratio goals by the end of the current fiscal year. Note though that management is not guiding that though.
The stock has not had this low a valuation compared to expected earnings in a very long time. Normally the stock trades anywhere from 20 to 40 times expected earnings. A continuing reduction of debt combined with the expected earnings will likely result in significant stock price appreciation.
This is a fast-growing company that is expected to continue to grow quickly. A return to a price-earnings ratio of roughly 30 would be equal to the growth rate that is projected for the next few years. This is another way to value the stock. That would imply a considerable appreciation of the stock price from current levels. There would even be more appreciation potential from the rapid growth of the company.
That makes this volatile issue a strong buy on the stock price recovery and likely continuing fast growth. However, the stock price volatility makes the issue suitable only for those that can stomach the extreme stock price volatility. This is probably not for conservative and income-oriented investors.