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Shares of Chart Industries, Inc. (NYSE:GTLS) have seen a huge fall over the last couple of days after a mega deal was really ill-received by investors. To understand where investors are coming from and to judge the impact of the transaction on the business, I am going back to June, when I concluded that it was almost time to buy the dip.
Back To The Summer
Chart Industries is a play on the energy transition, LNG in particular. The company has long been positioned this way. While it took a long time for the positioning to result in tangible sales and earnings growth, 2022 was the year in which the preparations would come to fruition, unfortunately for the wrong reasons.
The business relied largely on large orders, which created lumpy sales and earnings trends. Originally, the company guided for 2020 sales at around $1.75 billion and earnings between $5 and $8 per share. After a tough year, the company guided for 2021 sales at just $1.3 billion on which earnings were originally seen at just $3 per share.
Despite this outlook, shares rose to the $120 mark late in 2020, and shares later rose to the $200 mark in September of last year when energy prices were starting to increase already. Shares fell to the $110 mark in February 2022 on the back of the outbreak of the Russian war, as shares quickly recovered again. This was driven by a resilient outlook for 2022, originally calling for sales at a midpoint of $1.775 billion on which earnings were seen at around $6 per share. With shares trading at $180 in June of this year, I found it a bit too early to get involved, as later that month shares fell to the $150 mark.
What Happened?
In the five months since my last take on Chart Industries, the company posted second quarter results late in June. Second quarter sales rose 25% to $404.8 million, as adjusted earnings rose twenty-three cents to $0.88 per share. While growth looks reasonable, the issue is that the midpoint of the sales guidance was cut to $1.76 billion, on which adjusted earnings are now seen at just $5.40 per share.
In October, the company posted third quarter sales of $412.8 million as adjusted earnings of $1.49 per share were quite strong. The reported sales understate the strength of the business with an order intake of $729 million resulting in a sky-high book-to-bill ratio, as the backlog doubled on an annual basis to more than $2.2 billion. The company cut the 2022 guidance again, now seen at a midpoint of $1.67 billion in sales and earnings at $5.12 per share, as the company introduced a very strong 2023 guidance.
For the upcoming year, the company sees sales at a midpoint of $2.15 billion on which earnings are seen at a midpoint of $8 per share.
With 36 million shares trading at $240 at the time, shares rose on the back of these results, the 2023 outlook, and further intake. The company was awarded an $8.6 billion equity valuation. Including half a billion dollars in net debt, the valuation stood at $9.1 billion, equal to about 5 times sales and nearly 30 times forward earnings.
A Bombshell Deal
On the 9th of November, Chart announced a $4.4 billion deal to acquire Howden, a provider of mission-critical air and gas handling products and services. Typical products to think of include compressors, blowers & fans, rotary heaters, and steam turbines. Three-quarters of the deal will be paid for in debt and the remainder in preferred stock.
Howden generates $1.8 billion in revenues, on which it posted adjusted EBITDA of $340 million. This implies a purchase price at 2.5 times sales and around 13 times EBITDA, that is ahead of synergies. Besides the lower earnings multiples, the company sees huge synergies, pegged at $175 million in year one, expected to rise to a quarter of a billion in year three.
Net debt will increase to $3.8 billion as leverage will increase to an estimated 4.25 times, which is high, but given the sector, it might be manageable. That being said, there are risks as well, as an economic recession might hurt energy prices and thereby the order book as well.
Despite the lower sales multiple and the anticipation of huge synergies, shares took a huge beating, essentially from $240 to $140 overnight, as the $100 move lower cut the equity valuation of the company by $3.6 billion, almost equal to the valuation of Howden in this deal.
What Now?
The truth is that I do not think that the current move is the right one. Chart Industries has been a focused play on the energy transition, as this deal creates diversification and scale. At the same time, the transaction results in leverage as well as investors fear “diworsification,” which hurts the earnings multiples applied to the stock. Furthermore, Chart has not been too lucky with dealmaking in the past.
The reality is that the deal is likely hugely accretive to earnings per share, certainly if synergies are delivered upon. Depending on a lot of moving items, I see potential for earnings to rise to $10 per share (or more), but these are quite lumpy estimates and earnings of course. If that is the case, valuations are quite low and today’s prices represent a huge buying opportunity.
Right now I am a bit puzzled. The move is a bit large, some strategic questions can be asked, and leverage is high. On the other hand, the deal looks quite fair, certainly if synergies can be achieved, as the share price move feels like quite an overreaction.
Amidst these moving targets, a small speculative position in Chart Industries, Inc. might be the way to go here, although I have to stress the highly speculative element to the thesis here.
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