It's great to have a solid core business that can pay the bills in the bad times, and that's how I look at Chart Industries' (NYSE:GTLS) core industrial gas business. It's never going to be an exciting growth business, but it can do more than just keep the lights on. Meanwhile, this company also has attractive leverage to large-scale LNG projects and the future growth of alternative fuels like hydrogen. I also applaud management for restructuring the business more in keeping with its long-term core focus.
I liked Chart Industries back in April, and the shares have come close to doubling since then (they actually did double, but have come back a bit since). Although I do think the more energy-exposed parts of the business will need some time to recover, the LNG business remains attractive over the long term, and the company has done well on costs. Despite the sizable move in the share price, I do still see some upside here.
A Pretty Good Second Quarter On Balance
In a quarter where most industrial companies reported double-digit revenue declines and companies with more exposure to oil/gas did even worse, Chart had a surprisingly strong quarter. Revenue beat expectations by more than 6%, with EBITDA coming in about 24% better than expected on good cost-out performance.
Revenue was basically flat as reported but down more than 7% on an organic basis. The Energy and Chemicals (or E&C) business declined about 13% in organic terms, driven by the 45% organic decline in FinFans and offset partly by the 35% growth in the Cryo business. While natural gas processing revenue declined 22%, LNG revenue still rose more than 50% this quarter.
In the Distribution & Storage businesses, revenue declined 4%, with D&S West down 8% and D&S East up 3%. Overall, demand for industrial gas equipment (bulk and packaged) remained pretty healthy, with revenue down about 3% and 4%, respectively.
Adjusted gross margins were healthy, rising 160bp yoy and 60bp qoq. E&C saw a big boost to margins (up 7pts yoy and almost 5pts qoq) from stronger margins within, and mix shift toward, Cryo. D&S gross margin eased off both yoy (down 270bp) and qoq (260bp). With healthy gross margins and good performance on cost reductions, EBITDA rose 20%, while adjusted operating income rose 7%, with margin improving 80bp. On a segment reported basis, FinFans generated a small loss, while both Cryo and D&S West produced margins in excess of 20%. All told, outside of the impacts of Big LNG, underlying profitability looked quite good.
Given the weakness in the energy sector, it's not too surprising that orders declined this quarter, falling 17%. E&C orders declined 33%, with a sharp decline in FinFans (natural gas processing, LNG, etc.), and Cryo down about 5%. D&S orders declined 6%, as again the industrial gas and fueling businesses remain comparatively healthier. Reported backlog declined 7% yoy and 5% qoq, though adjusting for Calcasieu (a "Big LNG" project), the backlog was up 1% yoy and down just 2% qoq.
A Divestiture That Makes Some Sense
Chart announced about a week ago that it had reached an agreement to sell its cryobiological business to Cryoport (CYRX) for $320 million in cash. The deal values the business at about 3.8x trailing revenue (versus 2.2x for market value of the entire business today) and between 10x and 12x trailing EBITDA depending upon the adjustments you make to the EBITDA basis.
The cryobio business is mostly a life sciences business, selling equipment and systems that are used to preserve and transport biological materials that must remain chilled or frozen - tissue samples, blood, plasma, certain medications, and so forth. There was practically no overlap with Chart's other businesses, and the facilities themselves were basically standalone operations, and it's not a particularly robustly growing business at this point.
While the cryobio business was not hurting Chart, I view this as a good deal for the company, and the cash will help deleverage the company.
A Foggy Near-Term Outlook, But A Brighter Future
I'm still pretty excited about the long-term potential of Chart Industries across its business.
There are definitely near-term challenges in the natural gas and Big LNG businesses. Given weakness in energy prices and the damage done to E&P balance sheets, there could well be multiple years of weak investment spending in the energy sector, reducing demand for Chart's systems. On the LNG side, the finalization of regulations for rail shipments of LNG in June was definitely a positive for the company (which has a portfolio of LNG-by-rail products), but sanctioning timelines for LNG projects have definitely slipped, and this is not a great environment for funding new projects of this sort.
Longer term, though, I'm not worried about either business. There's been significant investment in North American chemical production capacity that relies on natural gas production (driving eventual demand for natural gas processing equipment), and the long-term economics of LNG exports still make sense.
On the industrial side, my earlier comment about industrial gas not being an exciting growth business shouldn't be construed as meaning there are no growth opportunities. Companies continue to find new applications for gasses (like nitrogen dosing for plastic beverage bottles), and markets like cannabis still offer attractive growth. My point was more that this is a "razor blades" type of business that is fairly steady through good times and bad.
One area of growth that is still very much worth watching is hydrogen. Fuel cell enthusiasts have been waiting for decades for this technology to become viable, and it does seem to be getting closer. As I wrote in a recent piece on Cummins (CMI), "green hydrogen" (hydrogen produced by renewables-powered electrolysis) could become economically viable relatively soon, making fuel cells a more viable option as an alternative to hydrocarbon fuels and battery-based electric drivetrains. As hydrogen needs to be stored, transported, dispensed and so forth, it fits easily within Chart's core competencies.
The Outlook
Based on recent performance, the cryobio sale, and recent guidance, I've made some modifications to my model. The basic gist of these changes is positive, with higher revenue and margin expectations over the next five years. My longer-term outlook hasn't changed as much, though my long-term revenue growth rate has risen to around 5% (from closer to 4%) and my long-term FCF growth rate is still in the low double-digits.
Discounted back, those cash flows still support a high single-digit annualized return for shareholders. I also get a fairly attractive margin/return-based EV/EBITDA fair value with a forward multiple of almost 13x based upon operating margins getting to the mid-teens in 2022.
The Bottom Line
Chart shares have clearly had a great run, and it's worth remembering that the company's reliance on cyclical markets means that there will likely always be above-average cyclicality to sentiment. Still, I believe management is doing a good job with the business, and I think the long-term opportunities across energy, industrial, and fueling markets remain attractive. With a prospective return that I still find pretty solid on a relative basis in an expensive market, I think there's still upside here.
