Although it is much too soon that the LNG market opportunity is really coming back, Chart Industries (NASDAQ:GTLS) has been strong over the past year (up almost 40% from the time of my last article). Attributing performance always involves some guesswork, but I believe Chart has done well due in part to optimism over the new administration (as it pertains to tax reform and supporting U.S. energy exports), growing confidence in an industrial recovery, optimism that LNG activity is bottoming out, and at least some recognition of self-help efforts at the company.
Chart Industries appears priced to generate a long-term return in the 9% to 10% range, which isn't bad considering that that leaves some upside from a more bullish “strong LNG” scenario that could potentially add many hundreds of millions of dollars to the long-term revenue outlook. Although management has been sounding more upbeat of late, I'd caution readers that these shares are have been more volatile than average in the past, as the market has swung wildly from optimism to pessimism over the outlook for expanded LNG-related business.
The Wait Goes On For LNG...
The idea of leveraging the U.S.'s considerable natural gas reserves into LNG exports to gas-poor countries like Japan, India, and so on has been an appealing one for some time, and a significant source of bullish momentum in Chart shares in the past. Unfortunately, the significant energy price declines of recent years (as well as regulatory uncertainties) significantly altered the long-term return potential and led many would-be operators to slam the brakes on plans for LNG export facilities.
With that, Chart's LNG-exposed Energy and Chemicals segment has taken some hits. Revenue has declined sharply (down 15% in 2015 and down over 50% in 2016) on postponed construction plans, and LNG has fallen back to about one-quarter of the segment's revenue, with gross margins pulling back (excluding high-margin short-turn work) on lower scale efficiencies. The last six to nine months has sounded more encouraging, though. When management reported fourth quarter earnings back in February, the tone was pretty upbeat on the prospects for demand growth in 2018.
To be sure, there is a lot of order potential out there for Chart. In particular, LNGL's (OTCPK:LNGLY) Magnolia still contemplates four 2Mtpa trains, with only half of that in Chart's backlog and the potential to expand even further. Likewise, Tellurian (NASDAQ:TELL) and Cheniere (NYSEMKT:LNG) are both in Chart's “stable” of future LNG customers, though magnitude and timing are still unknown. All told, there are potential orders out there that add up to hundreds of millions, if not over a billion dollars, for Chart provided that companies move forward with smaller-scale LNG facilities. With global imports of LNG up another 5% in 2015 (despite a decline in imports in Japan, the largest consumer, due to more nuclear power production and slated to continue growing), large-scale global LNG trade still makes sense.
It's also worth remembering that Chart does bring something a little different to the party. The company's brazed aluminum heat exchangers are very efficient, allowing for smaller modular LNG facilities in the U.S. that cost around half of what large Australian facilities have cost. Given that cost is a major deciding factor, that's not going to hurt the company's prospects.
… But It May Go On A While Longer
Although I am generally bullish on the outlook for LNG trade, I think it's fair to present at least some of the more bearish arguments. One of those arguments is the growth of renewable fuel sources like solar and wind – although these power sources cannot fully replace fossil fuel or nuclear-based generation today (and likely won't for some time), they are significant incremental capacity alternatives that have their own set of advantages (including reduced pollution). I'd also note that LNG isn't the only way to transport gas around the world – there's only so far that pipelines can reach, but there is at least a conceptual risk that pipelines could supply more of the needs of major importers.
Thinking more generally, it's also worth remembering that times change. It wasn't so long ago that companies like Cummins (NYSE:CMI) were talking up the prospects for natural gas-powered commercial trucks (whether in the form of CNG or LNG), and some were speculating that passenger vehicle companies in the U.S. and Europe could follow in the footsteps of China and encourage more development in this direction. Now everybody is talking about electric – electric cars and even electric commercial vehicles – and LNG seems like only a modest technology-bridging opportunity.
Industrial Still Often Overlooked
There is no doubt in my mind that LNG is the biggest swing factor between the various scenarios I model out for Chart, but that doesn't mean the other businesses are unimportant. Even when LNG orders were swelling results for the Energy and Chemicals segment, the industrial gas-driven Distribution and Storage was still the larger business (even when subtracting out the LNG-driven part of D&S).
In fact, Chart has been the beneficiary of nearly two decades of solid (albeit cyclical) mid-single-digit growth in demand for industrial gases. Industrial gases are used everywhere – they're used for welding, propellants, cooling/cryogenics, fire safety, and product fabrication, and that's just a very brief high-level summary. Said more glibly, there are reasons that Air Products (NYSE:APD) and Linde (OTCPK:LNEGY) generate close to $30 billion in combined revenue. As industry activity expands, so too should demand for industrial gases and the equipment needed to produce, distribute, and store those gases and that will flow to Chart.
I'd also note Chart's efforts to grow its business in other directions. Chart is under-leveraged to services; bulk containers require extensive refurbishment every decade or so (costly close to a third of the initial purchase price) and there are many other opportunities to help customers install and service/maintain equipment. These opportunities can be quite lucrative (as seen with companies like Atlas Copco (OTCPK:ATLKY)) and this seems like a low-hanging opportunity for Chart.
Chart has also been getting more active on the M&A front. I'm not sure whether the company is easing off its previously demanding return hurdles for M&A, but the company has done two deals in the last year that expand and diversify the E&C business. Hetsco brings in specialty welding capabilities that fit in with that expanded focus on service, while the most recent acquisition (about a week ago) was for Hudson Products – a company that makes air-cooled heat exchangers for the petrochemical/refining markets, as well as axial flow cooling fans (an area where Colfax (NYSE:CFX) has a notable presence).
Chart has the wherewithal to be quite a bit more active on the M&A side if management chooses to go that route (and the company recently transitioned to a new CEO). Chart could do another Hudson-sized deal (about $400 million for about $200 million in revenue) without much strain, and there are a host of companies in areas like gas handling and service that could offer incremental value to Chart without a lot of integration risk. I would expect Chart to look to expand into adjacent markets on the equipment side (as opposed to diving deeper into areas like LNG) and continue looking for service businesses that complement their existing product lines.
As is, I expect strong mid-single-digit long-term revenue growth from Chart. If LNG plans go from drawing boards to reality in a big way, several hundred million dollars more could be up for grabs, taking the long-term revenue growth potentially to and/or above the double-digits. My base-case estimate is for gross margin to improve into the low 30%'s (versus a prior peak of around 34%) and for operating margins to improve into the mid-teens, with a high-teens EBITDA margin. That all would support high single-digit FCF margins and strong double-digit free cash flow growth from 2018 on.
All of that means that today's price works out to a roughly 9% to 10% total return, which really isn't too bad in this market, and that's not including the upside to a stronger LNG market over the next few years. I'd also note that Chart could itself be a buyout candidate. Colfax is quite comfortable with gas handling as a business, and I could see companies like Fortive (NYSE:FTV) or Dover (NYSE:DOV) also potentially having some interest. By no means am I basing any sort of buy thesis around this happening (I think it's quite unlikely), but it could be an effective floor for the stock.
The Bottom Line
Chart is off a little bit from its 52-week high, and I do have some concerns that optimism around lower corporate taxes and a more proactive/supportive environment for U.S. energy exports could fade. I would also note again that these shares have been volatile in the past as the fortunes of LNG have waxed and waned in investors' eyes. Still, though, I think it is a quality industrial gas infrastructure company and one that will see improving results in 2017 and beyond. Orders have begun to grow again, and revenue, margins, and backlog should improve from here.
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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.