Chart Industries (GTLS) stock often trades with a fair amount of anticipation. The relatively high price-earnings ratio means that this had better be a high performance future or else. Management had originally not included any projections of large orders in the earnings guidance because they were unsure of the timing. This time around the market optimism about those large orders appears justified. The arrival of those orders could signal a large earnings jump next year.
Source: Chart Industries First Quarter 2019 Earnings Press Release
Orders took a huge jump from the pace of the fourth quarter. The March quarter numbers nearly doubled the year before figure while jumping about 50% over the fourth quarter period. This is a relatively small competitor to Air Products and Chemicals (APD). So large orders have a relatively significant impact on the future profitability of the company.
Lead times here are fairly long. During the conference call, management clued a few analysts in that most orders received from now on would have a major impact in future fiscal years while impacting the current fiscal year minimally. Still, management raised the earnings guidance for the fiscal year. If the current order pace maintains itself, the earnings guidance for fiscal year 2020 could show a large leap over the earnings of the current fiscal year.
Stock Price Action
This stock has been leading (or even projecting) the company recovery progress for some time. The price-earnings ratio has remained well above average. Therefore, the lack of a strong pricing reaction to the earnings news was not unexpected. Clearly, the market is expecting a bright future for the stock to continue trading at this high price-earnings ratio level.
Source: Seeking Alpha Website April 18, 2019
The stock price has risen about 50% from the year-end lows but considerably less from the September highs. The earnings news and revised earnings guidance obviously brought a collective yawn from the market. The combination of rising order rates and some exciting acquisitions had already raised expectations. Therefore, the fulfillment of those expectations was not a reason for the stock price to run higher.
The main investment objective is to figure out if future earnings will exceed current expectations. That appears to be very likely despite the currently high price-earnings ratios. This company has purchased some significant divisions from others in the industry. Management also purchased some private companies in the process. Management has a long history of quickly integrating acquisitions by allowing the production to operate as it has before the acquisition while combining the sales effort at the corporate level.
Restructuring Costs And Benefits
This company has a long history of whipping money-losing divisions into shape quickly. Indeed, management already announced some charges in the first quarter related to rearranging facilities in the latest acquisition for more profitability.
Source: Chart Industries First Quarter 2019 Earnings Press Release
First quarter is traditionally the slowest quarter for the company. Yet earnings managed to double the previous year before all the reorganization charges shown above to save money.
The acquired VTTI unit in particular seemed to be staffed too high and operating too many assets for the level of activity. Management stated that they were exiting and consolidating the VTTI assets. They were also filling the backlog of low-margin orders and replacing that backlog with a campaign aimed at larger margined products.
Chart has long had a history of acquiring new products and then using the manufacturing capacity as well as its sales force to drive sales for those products. The company now appears to be large enough to introduce some new and improved products on its own. Management appears to be taking conservative steps by improving the product line in conjunction with customer comments. This company does little or no research and development that leads to disruption type products.
The manufacturing is done at a fair number of small plants rather than several large ones. Therefore, most manufacturing problems or challenges are straight-forward to resolve and rarely result in extended time disruptions that customers notice.
Consolidations of the manufacturing capacity is typically limited in nature during the recovery but accelerates as a cyclical down-cycle strengthens. Product obsolescence during the down-cycle also leads to plant closures and consolidations. Rarely do the costs exceed $10 million in a quarter though.
Sales in the first quarter were nearly as high as the fourth quarter. Since the fourth quarter is traditionally the company’s largest sales volume (in dollars) quarter and the first quarter is traditionally the lowest sales volume (in dollars), this would imply a significant jump in sales for 2019.
Margins can vary greatly. As management explained, some products have margins as low as 20% while others have margins approaching 40%. The relatively large order size means that the gross margin can vary quite a bit without implying a lack of operational and financial control. The gross margin was negatively impacted by the sales mix in the first quarter. While the market reacts coolly to margin decreases, the margin enhancing steps shown above imply some very good earnings comparisons for the rest of the fiscal year. Should the backlog continue to increase, the earnings comparisons will become even better in fiscal year 2020.
The balance sheet took a slight hit when the 2024 convertible bonds were reclassified to current. Those bonds are deeply “in the money” and shareholders have the right to convert at any time now that the stock price passed a certain threshold. Management has indicated that the chance of conversion at the current time is slim. However, just the ability of bond holders to convert meant that the bonds had to be reclassified as current.
Changes in current assets and liabilities of negative $57 million caused cash flow from operating activities to be a negative $33 million in the first quarter. The current asset expansion was caused by the rapid growth in sales, the acquisition related activities, and needed current assets due to the accelerating industry activity. When growth slows this company usually generates tremendous cash flows from its operations relative to its size. Tight management (in the past) has also generated cash from shrinking working capital during cyclical downturns to aid acquisition activity of more distressed competitors.
Management gained a foothold in India through the recent acquisitions. There is a large market in that country for liquified natural gas stations as more and more commercial vehicles choose LNG as an option. Management wanted a part of that action and is now in a position to pursue at least a portion of the business.
Typically, cyclical upswings in this industry last 5 to 7 years. The top of the cycle is usually marked by a fair amount of activity bidding on large LNG projects. That activity has just begun in the current cycle. The latest recovery began near the beginning of 2016. So the arrival of the top of the cycle in the next year or so should be expected by investors.
This stock is extremely volatile. In fact, the stock lost more than 90% of its value in the last downturn. Therefore, investors do not want to overstay their welcome in this security. Nonetheless, a very good next fiscal year appears to be certain. More large orders will probably lead to price appreciation in the current year regardless of when the orders ship.
Nonetheless, at the first sign of order weakness, shareholders should consider selling this investment and waiting for the next market bottom. This cyclical growth company tends to have higher highs with each cycle. But the lows can be really gut-wrenching and should be avoided.
Right now, the stock appears to be a candidate to double over the next 24 months. The latest acquisitions appear to have added a significant amount of business opportunities for management to capture.
This management typically allows the new acquisition to continue to manufacture at the facilities without disturbance. Rationalizations and consolidations tend to be infrequent events. The sales force though is consolidated. This is where management realizes the benefits of many acquisitions through a broader and more comprehensive product line.
The earnings for the current year are more than 90% fixed because of the fairly long product lead times. But this stock tends to rise and fall on order volume. Right now, that volume is rising very quickly. The high price-earnings ratio increases investment risk (especially if there is a disappointment). But the future looks better than ever.
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Disclosure: I am/we are long GTLS. 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.
Additional disclosure: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents, and press releases to see if the company fits their own investment qualifications.
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