When investing in industrial and energy stocks, investors are usually faced with a tough choice. Does one invest in traditional energy stocks, which often trade at low earnings multiples but with an uncertain future, or does one invest in higher-priced renewable stocks, which have stronger growth ahead but little or no profitability today?
There aren't many stocks that benefit from both traditional energy and future clean energy markets at the same time. But one industrial stock does. And even better yet, that stock appears to trade at a bargain price today.
Chart Industries straddles traditional and future clean energy solutions
Chart Industries (GTLS -1.39%) is a leading manufacturer of industrial-grade cryogenic tanks, heat exchangers, and other equipment that hold or manage gases and liquids that need to be purified, converted from one state to another, or stored at extreme temperatures.
That type of equipment has traditionally been used in oil and gas applications, but also in newer energy transition markets such as liquefied natural gas, hydrogen, helium, carbon capture, and water purification.
While Chart's stock has given investors an impressive mid-teens annualized return since 2018, there's a great case to be made the stock could double from here, or potentially more.
Up 117% since 2018, but 50% below all-time highs
The short answer as to why Chart can double is that it's 48% below its all-time high reached back in 2022. So really, if Chart just regains its all-time high, that would be a double from here.
In 2022, Chart was riding high, as demand for its LNG equipment soared in the wake of Russia's invasion of Ukraine. However, the stock plunged in November 2022 after the company announced the $4.4 billion purchase of Howden, a similarly sized company that manufactured industrial blowers, fans, and other rotating equipment.
Chart bought the company using almost all high-coupon debt, as well as a little bit of equity, and investors didn't take kindly to the purchase. That was perhaps due to the fear of an economic downturn and uncertainty about interest rates.
But Howden may actually be a home run
The thing is, while the market hated the Howden acquisition, it might actually be a strategic home run that could greatly increase shareholder value.
First, the acquisition isn't quite as expensive as first reported. In 2023, Chart has divested about $500 million of non-core businesses following the deal's close. So that will bring down debt marginally and lower risk.
But there are numerous ways Howden will improve Chart's results. As is usually the case in successful mergers, the new Chart is benefiting from both significant cost synergies as well as cross-selling opportunities. Management is on target to hit $175 million in cost synergies this year, on the way to $250 million in cost savings by year three.
But the company has really been outperforming on revenue cross-sell opportunities, with an extra $400 million in cross-sell orders already, trouncing the initial target of $150 million in year one and $350 million by year three.
Image source: Getty Images.
This success has been due to Chart and Howden's having highly complementary products and geographic reach, with Chart strong in North America and Asia and the Britain-based Howden strong in Europe and the Middle East and Africa. So Howden offices can sell Chart equipment to new geographies, and vice versa. Furthermore, instead of Chart's selling of tanks and Howden's selling of blowers in a book-and-ship manner, the combined company can now offer "full solutions."
Not only do full solutions bring in more revenue for the company, but they also enable Chart to become a more of a partner to industrial customers, rather than just another vendor. The result is deeper relationships, higher margins, and better longer-term visibility, reducing cyclicality.
The aftermarket segment is the crown jewel of the Howden deal
But perhaps the biggest positive the market is missing is that the Howden deal will turbocharge the combined company's aftermarket repair, service, and leasing contracts. These include repairs, equipment upgrades and life extension, predictive maintenance, digital uptime software analytics, and other services.
These types of service contracts are more tied to Chart's installed base, and therefore represent a more recurring, less cyclical segment. The beauty is that as long as the total amount of installed equipment grows every year, no matter if a year's sales are up or down, this business should grow along with it.
The legacy Chart business was successful in selling equipment, but it actually had a very low percentage of business coming from aftermarket services. However, Howden had a huge proportion of its business in aftermarket services of around 45%, and the combined business now has over 30% of sales coming from aftermarket services.
Not only should services revenue grow with the installed base, but there is still a huge portion of Chart's installed equipment not currently under service contracts. In fact, on its investor day presentation, management noted that less than 50% of Chart and Howden's combined installed base is under attached service contracts.
Management expects double-digit growth from this segment into the future, and the aftermarket business is also higher-margin, encompassing 45% of the combined company's gross margin dollars versus just over 30% of sales. So as the aftermarket business grows, it should make Chart a more consistent business and higher-valued stock.
Chart is way too cheap for a less cyclical business
On the same investor day presentation, Chart forecast mid-teens revenue growth off of 2023 numbers through 2026, but with a whopping mid-40% annualized earnings per share growth over that time as margins increase.
Management has already guided to having much of that growth come in 2024, with preliminary guidance for $5.1 billion in revenue and over $14 in earnings per share, up 46% and 128%, respectively, over full-year 2023 guidance, which has only nine months of Howden.
Still, even if earnings grow 45% for three years off 2023 guidance of $6.15, that would bring 2026 EPS to $18.75, suggesting mid-teens earnings growth even after 2024.
Given Chart's competitive advantages and what should be a less-cyclical business, I don't think there's any reason the stock couldn't garner a high-teens market multiple, which could push Chart's stock up to $300 or higher. That's especially true as Chart will have paid off more debt by then.
With Chart's stock hovering around $130 today, it looks like quite the bargain opportunity.
