Countries that make LNG tend to have too much of it, countries that want LNG tend not to make it, and the spread created by the supply/ demand mismatch creates some big opportunities for companies like Chart Industries (NYSE:GTLS).
In this week's episode of Industry Focus: Energy, host Nick Sciple and Motley Fool contributor Jason Hall take a deep dive into Chart and the LNG industry. Find out what you need to know about the company's recent past, how they're setting themselves up for big growth in the future, what to pay attention to with cyclical industries like this, why demand for LNG is only going up, some of the most exciting developments in LNG lately, and much more.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.
This video was recorded on April 25, 2019.
Nick Sciple: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, April 25, and we're discussing Chart Industries. I'm your host, Nick Sciple, and today I'm joined by Motley Fool contributor Jason Hall via Skype. How are you doing, Jason?
Jason Hall: Earnings season is upon us, my friend.
Sciple: Yeah, it's been a big week! Yesterday we had Tesla, Microsoft, PayPal, and Facebook all reporting on the same day. Me and Matt Dilallo last week previewed some energy names, took a look at Kinder Morgan's earnings. We're in the throes of it right now. Jason, I know you've got a lot of work on your plate. How's it been treating you?
Hall: Nucor, a steel company, we talked a lot about steel recently, reported. Pretty solid quarter. Actually, earnings were better this quarter than a year ago. And remember, last year was a record profit year. There were a couple of little things that caught my attention, a little bit of weakening in a couple of metrics. We'll see. I'm not going to predict the end of this steel cycle here, but I'm starting to pay a lot closer attention right now.
Sciple: Yeah, something to continue watching. As we mentioned, we talked about Nucor a couple of weeks ago. The way their management is able to ride through the cycle gives you a good indication of where things are moving in the steel industry. Definitely a company to pay attention to.
Jason, as I mentioned off the top of the show, our topic today is Chart Industries. This is a company that's really making some moves and is going to be an important player in the evolving LNG market as it plays out over the coming years.
Before we dive into that, though, I want to update on some oil news that we got this week. On Monday, United States officials announced that they are going to lift waivers that they had put in place on sanctions against Iranian crude. Back in November, the U.S. backed out of the Obama era nuclear deal with Iran and reimposed sanctions on Iran. Most of the major countries that receive imports of oil from Iran were exempted from that over a period of time. However, those waivers are going to expire on May 2nd, and the Administration has announced they're not going to renew those. Jason, as we get this news out, obviously Iran is a major global producer of oil. Taking any of that supply off the market is going to affect prices. How should investors be responding to this news? How should we should be thinking about it?
Hall: I think, just like anything when it comes to oil prices, things can change very quickly. And typically, they do. Just like any other major piece of information about supply, I don't necessarily think it's something I would call investable. If you're interested in investing in oil and gas, same rules apply: find your lowest-cost producers, find companies that have a durable competitive advantage. That's where you're going to find opportunity. Just another announcement that's going to affect global supply in some way. May 2, they expire. They're saying they're not going to renew it. [laughs] Let's see what they say on May 3. [laughs]
Sciple: Yeah. We've already seen, China is the biggest purchaser of Iranian oil, Turkey's also a major producer. Both of them came out and indicated that they're in opposition to the unilateral sanctions being put in place by the USA. So it's to be determined what response those buyers of Iranian oil may have. There are some question marks. You mentioned, if this oil does come off the market in a meaningful way, who's going to make up the gap? The first person folks think about is Saudi Arabia. However, they're feeling a little snake-bit after back in November, when the U.S. putting sanctions in the first place. Saudi Arabia expected this Iranian oil to come off the market. However, these exemptions were put in place, and all of a sudden, we had an oversupply scenario, the global price of oil moved down. Saudi Arabia has not committed to increasing its output of oil. We'll just have to see where this new supply might come from. This is layered on top of, Venezuela is having continuing issues of their supply coming off the market. And, you've got some civil unrest in Libya, which is also another major producer.
Again, as we look at these Iran sanctions continuing to play out, it's another part of this global tapestry of how global oil supplies are moving around. It's something to pay attention to. Like you said, probably not investable, but something to be aware of.
Sciple: All right, Jason, before we dive too deep into Chart, I do want to just talk a little bit about what the opportunity is in LNG and what the thesis is. What really appears to be driving the business for Chart -- we'll talk about this in more detail on the second half of the show -- is this global LNG market. So, Jason, for our listeners who may not be familiar, first off, what is LNG? Then, why do we think this market is going to have to grow at least over the coming five to 10 years?
Hall: LNG, liquefied natural gas. You drill a hole in the ground and you pull natural gas out, it's in a gaseous state. At ambient temperature, it's a gas. That's fine here in North America and parts of Europe, where the supplies are. You can put in great big pipelines and you can pipeline it wherever you need to really cheaply. It's easy to move around to use as energy in relatively regional considerations. But you want to start getting all this huge wash of natural gas that we have in North America and you want to monetize it where the demand is growing -- in Southeast Asia, parts of Europe that are looking to reduce their reliance on coal, parts of Africa where there's economic growth, and maybe areas that don't have the supplies -- you super-cool it into a liquid. The energy density greatly increases -- in other words, you can get substantially more natural gas as a liquid into a certain space. So you can put it on these big tankers, you can ship it around the world in a lot more cost-effective manner.
Really, the thesis for LNG is, there are a few key places in the world where there are massive supplies of it. You have Australia with a ton of it. You have the U.S. and Canada with a ton of it.
How this all ties into Chart, we'll talk a little bit more about. Chart essentially make some really important pieces of equipment to facilitate turning natural gas into a liquid, getting it onto a container ship, and then getting it where the demand is. But it's huge. If you think about what's happening right now in the United States, FERC is the federal agency that oversees approval of liquefied natural gas producing and export facilities. Right now, we have... what's the exact number, Nick? Do off the top of your head? Is it 13, 18 that have been approved?
Sciple: There's 18 proposed or in pre-filings. I think there were a dozen that have been approved as of the last year or so. A large number of projects. And when you think about these projects, these are multi-multi-billion-dollar projects. Really significant capital invested in these things. So if you think about 30 of these -- 12 that are already up and running and approved and 18 that are in the process, that's a lot of cash behind those projects.
Hall: Oh, yeah. The small ones can cost $10 billion to build. The big ones can cost $25 billion to build. There's a substantial amount of capital that's already been essentially earmarked for these facilities that are going to be built. This year, we're starting to see the first really large number -- I think there's only a couple that are in operation in the U.S. This year, there's going to be several more coming online. I think between now and 2023, we're probably going to see half a dozen or more additional ones that are going to come online. I think Chart Industries says that they're targeting right now what's approved, the ones that maybe there's already shovels in the ground, starting to work. They're saying that they have maybe as much as $800 million in opportunity for revenue just on these big LNG deals. That's pretty big.
Sciple: Yeah. We'll move on to Chart in the second half of the show, just a couple of things I just want to draw through to highlight what Jason mentioned. Obviously, that the main thesis here is, there's a huge spread between the price of natural gas in the U.S. and these places that have large amounts of natural gas vs. the price in places where people really want it, places like China and India that have a huge, huge demand for energy, but just don't have the natural resources that we're fortunate enough to have in the U.S. So you've got lots of companies, producers or natural gas in the U.S., and these low-cost places want to liquefy that natural gas, send it overseas, and just pocket that spread. It's a really big opportunity as we've had the explosion of shale in the past decade, opening up access to fuels that we never thought we'd have access to before.
To give you a number, global energy demand is set to grow by 18% by 2035. Natural gas is expected to be 40% of that growth. Part of it is because the prices of natural gas are coming down. Also, part of it is that natural gas is a much cleaner burning fuel. You have places like China that, for a long period of time, struggled with issues like smog and emissions. So they've allocated a lot of government capital to try to solve that problem. One of the solutions to that is LNG that we're providing from the U.S. and across the world, and Chart fits into that.
Alright, Jason, now let's talk about how Chart fits into this whole LNG story. You mentioned when we talked about the LNG market how natural gas comes out of the ground or out of the well in a gaseous form. You can move that from place to place via pipelines, at least when you're moving across land. However, if you want to ship LNG over a long distance whether via rail or you want to send it more likely by ship, you have to put it into a liquefied state, and that requires super-cooling that gas down enough until the natural gas liquefies. That's where Chart fits in.
Jason, do you want to talk a little bit about the products and services that Chart provides to liquefy that gas, and what happens, what the special sauce is for Chart, that makes that happen and the value they create?
Hall: Chart describes itself as a cryogenic gas processing equipment manufacturer. The roots of its business are more in the industrial gas side. We'll talk a little bit about that. It sells equipment to industrial gas companies. But when it comes to the natural gas, and this is really where the growth thesis lives, is in building the equipment for liquefaction. It's raised heat exchangers and air-cooled heat exchangers that help turn the natural gas into its liquid state. These are typically pretty expensive, complex pieces of equipment. This business is very peak and valley driven based on the demand cycle, based on capital allocation budgets for the energy industry and its big buyers.
It also manufactures the equipment for storage. A big potential growth market coming out of this LNG supply is natural gas and transportation. For example, an over-the-road tractor-trailer needs a large supply of fuel. Chart makes the fuel tanks that would go on a tractor-trailer. It also makes the cryogenic storage tanks for biomedical applications, you think about some of the applications where that comes in. Actually, it's kind of a funny little side play. They've started talking about how some of the equipment that they manufacture actually has some real practical applications in the pot business. We're not going to talk about it as a cannabis stock, but somebody is probably going to start talking about it as a cannabis stock at some point here soon. But if you think about, again, that core business, it's about turning gaseous state things into liquids -- in this case, natural gas -- storing them and also moving them from place to place, being able to distribute those fuels.
The business is divided up -- they've recently changed it. They have an Energy and Chemicals segment, which obviously focuses on large energy industry customers; also, a lot of the industrial gas customers are going to be in that Energy and Chemicals segment. And then they have a Distribution and Storage business that they divide up into two geographical regions. There's Distribution and Storage West, which is the Americas. It's mainly North America more than anything, that's where most of that volume happens. And then you have East, which is kind of the rest of the world, I guess is the best way to describe it.
Sciple: Yeah. Not to get too technical about what Chart does, but basically, like Jason said, if you have a gas of any kind, whether it's natural gas, natural gas liquids, carbon dioxide, they talk about using liquefied carbon dioxide for the cannabis applications. They also have applications for hydrogen in fuel cells and things like that. Chart makes what essentially looks like these big metal boxes that super-cool that material down so it can be used for whatever industrial application they have. And then they make the material that, once you've cooled it down, will keep it cool for transportation. Of course, as we mentioned for LNG, that's really key to taking LNG from markets where there's a huge oversupply or there's some surplus, like in the U.S., and bringing it to places where there's a shortage like China, India, places like that.
You mentioned, too, Jason that Chart is a company that is dependent on the hydrocarbon investment cycle, particularly tied to natural gas. There's going to be ups and downs, and Chart has been no exception to that. Chart hit its peak back just before the beginning of 2014, when there had been that big swing-up in the shale industry, and there was a lot of bullish sentiment for where natural gas could go. However, around that time, China really cut their demand for equipment, and Chart was punished. It really bottomed out in 2016. But it's really starting to trend back up.
Jason, as we see how Chart has changed over these past few years and repositioned itself, what's changed with the business? Is the business healthier today than it might have been back then when it hit its all-time highs?
Hall: Yeah, I think there's no doubt that it's healthy. To a certain extent, there was just a lot of bad timing. Management had made the decision to go whole hog into China, invested a ton of capital to build out manufacturing capacity there. At the same time, they'd gone on a little bit of a spending spree building a bigger business, but not necessarily a better business. It acquired some personal biomedical use stuff, think about somebody who needs an oxygen concentrator, maybe they have COPD or something like that. So they bought some companies that do that, but they really didn't fit in the company's core manufacturing competencies. Anyway, then the worst-case scenario happens. Pretty much everybody was bullish on natural gas, and all of its potential prospects, right when all of the material spenders said, "OK, we're not going to spend anything there." And Chart got caught at the top.
And as a result, the past four years or so, the company has spent a lot of time restructuring the business. It's sold off Care Medical, which was all of the personal oxygen concentrators business, last year. They've consolidated a lot of their manufacturing to better leverage the operations, to improve gross margins, put them closer to customers, put them in a situation where their shipping costs would be better for things that they're shipping to customers they're not necessarily close to.
It's certainly paid off. It really has. It might not look like it if you just look at the last quarterly report, but going back to a few years ago, margins are bouncing back. Their operating income is better. Operating cash flows have certainly gotten much stronger over the past three years.
The company's also continued to make some acquisitions, too. But if you look at them, those acquisitions have been really focused on things to strengthen the core business. One thing they did, I think it's been three years ago now, was they bought a business that was really focused on the aftermarket services side. This is really important, especially going forward as Chart is more and more invested in the energy industry as a customer. The cycle to allocate capital to buy the expensive stuff Chart makes can be so peak and valley driven. Chart will be able to generate more consistent revenue by providing services to those customers to maintain and support the equipment that it really wasn't doing as much of. So, that was a really nice, smart acquisition a few years ago. More recently, the company bought VRV, which is based in Europe. That was interesting because they're kind of in the same business, but they sold to different customers and some different products. So it helps Chart make their core a little bit bigger. At the same time, they announced a couple of deals in India recently. VRV's management, through their contacts and their relationships, led that push. So now, Chart is positioned really well to take advantage of the growth in demand for liquefied natural gas particularly in India.
It's really interesting, what's happened. I think a really important thing to mention is the company's gone through three CEOs just through a strange series of events. It moved its corporate headquarters from Ohio to just outside of Atlanta, Georgia. A number of key executives left the company, which is not uncommon when a company moves its headquarters like that. But through all of that churn in management, the company's continued to execute on its strategy to build a better, more profitable, nimbler, more lean business. And it's really paying off. The timing that killed Chart in 2014, 2015, it's flipped the other way now, because the company is really, really positioned to be lean and mean and really nail it as these decisions are made to build out these liquefied natural gas facilities.
Sciple: Right, exactly, Jason. What's interesting is, the story when it comes to the spread between natural gas prices among countries, how countries want to have cleaner energy, that story is still the same; however, the enthusiasm behind this industry has really waned off. The story has not changed; however, the valuation has changed. From an investing point of view, that's something I want to call attention to.
We've talked about how the company has changed over the past several years. They just reported earnings on April 18. Let's talk a little about where the company is today and where their trajectory is going forward.
Some good signs with their earnings back on April 18; some not so good signs. I just want to get your thoughts on this. Revenue was up about 19%. Orders up 60%. However, earnings per share down around 83% year over year. Gross margin has fallen by a little over 4%, 420 basis points. Jason, when you look at that earnings number, what should investors be taking away? How should we think about that report?
Hall: A couple of things. Chart is still at the tail end of some of its restructuring. What that means is, there are going to be some non-recurring expenses that hit its GAAP, its generally acceptable accounting practices, earnings per share number. So I think it's important that you look at the adjusted number as well, with the caveat of, what are the adjustments? What is management saying behind it? Because every company is going to have something that they can adjust every quarter. Knowing the difference between a really good adjustment that makes sense vs. an adjustment to try to meet Wall Street's numbers is really important. I think that's an important thing to know.
For example, the company took a $7.4 million expense in the quarter. It was unexpected. They said they did it because they identified it as part of starting to roll in some of these -- like the VRV acquisition -- starting to roll some of these things together. They identified a way that's going to put $6.5 million a year on the operating income line. So you spend $7.4 million one time to pick up $6.5 million every year going forward? That's OK. That's a smart decision to make.
Sciple: And if you adjust for that, I believe the gross margin actually trended up. It's something to be aware of as you look at the GAAP accounting strategy.
Any last thoughts on the earnings report, Jason, before we move on to where we can see the trajectory of this business moving forward?
Hall: Yeah. Again, because you're going to see so much cyclicality in its results, even from quarter to quarter, you really want to look at the trends. That's the main thing. If you look at the company now vs. two or three years ago... cash flows are harder to manipulate than GAAP earnings using adjustments. If you look at the operating cash flows, it's certainly trending in the right direction. And that's where you want to live right now.
Sciple: Yeah. Let's talk about their earnings. They increased their revenue guidance. It was previously in a $1.26 billion to $1.31 billion range. They trended that up by $5 million across the board. They've said that there are opportunities for big LNG. They moved those up. It was a $400-$500 million projection, now $600-$800 million projection. So, management really across the board increasing its guidance as they look forward. It really seems to be firing on all cylinders, Jason. Obviously, you never know what you're going to get from the global commodity market. But, what is going to run into the way of this company's growth? What could disrupt what seems to be what has to happen from an LNG point of view?
Hall: One of the things that makes me pretty optimistic is just the sheer number of these LNG export facilities that have been approved and that final investment decisions have already been made on. It's not just getting the regulatory approval; but the company that's behind it has leased or purchased land to build it on. They've done that. They've signed a contract with a construction company that's going to be the general contractor to build it. They've lined up investors to that have committed to start spending money. You're seeing a ton of that. That means that even if a third or a quarter of these don't get built, or they don't get built for five years longer out than we're expecting, there's still a tremendous, tremendous amount of these orders, these facilities that are going to get built.
Another thing, too, this was really, really huge -- if you looked at Chart's backlog, and this is their committed backlog, this is customers that have signed on the dotted line, paid a deposit or some other way of material locked in to buying equipment, I think it's the biggest it's been in four or five years. It's pretty substantial. What makes that really interesting is that Chart's backlog pretty much never goes up from the end of one year to the beginning of the next year. It always declines because companies spend money at the end of the year and they don't spend money at the beginning of the year. Chart's backlog went up like 40% or some significant number. Its booked orders went up like 60%. Those are really positive trends that this is the real deal, that things are good.
Sciple: Yeah. And on that 60% number, it's worth mentioning, 51% of that, if you take the acquisitions out, they're still at 50%. 50% of that is organic from the existing business. Really good positioning. We haven't even mentioned that outside of LNG, from the traditional way we think of how natural gas being used, there's been some real developments when it comes to using LNG as a fuel. I know Chart signed some deals in Germany. Germany has recently put some legislation into place that you don't have to pay any toll road fees if your truck uses liquefied natural gas for its fuel. Chart has signed some deals to do that. President Trump signed an executive order earlier this year that pushed the Federal Railroad Administration to alter rules, allowing shipment of liquefied natural gas by rail. Obviously, as there's rules allowing easier shipment of natural gas by rail, that's going to increase demand for liquefied services. So you're getting the spread as a tailwind between places like the U.S. and the rest of the world, but as well, from a regulatory point of view on using LNG as a fuel in vehicles and things like that, there appears to be some tailwinds there.
You mentioned, they think the cannabis opportunity over the long term can be a multiple-hundred-million-dollar opportunity. They think fuel cells can be a big opportunity for them from the hydrogen point of view. Obviously, it's going to be choppy depending on demand, but Chart has a lot of tailwinds behind them for what they do, which is very interesting from an investing point of view.
Hall: Agreed. One thing that we haven't mentioned is the domestic petrochemicals growth. I think there's something like $200 billion in investments that have been green-lighted to build out petrochemical manufacturing capacity on the U.S. Gulf Coast. This isn't anything as large as the LNG export facilities. But petrochemicals use natural gas as a feedstock. There will be applications that need that cryogenic cooling. That's another place where Chart's probably going to continue to see growth.
Sciple: Sure. The company has targets for what they would like to see by 2021. They want to see revenue growth greater than 40%. They think they can expand their margins by 700 basis points or more. Obviously, management is confident in their opportunity.
Jason, as you look at this investment going forward the next few years, if investors are looking at buying shares today, how should they think about doing that? When you're going to hold this company, there's going to be volatility. What do investors need to keep coming back to if you're going to hold this company as part of your portfolio for the long term?
Hall: Because of the fact that it's so associated with natural gas right now, and it is materially important to the growth thesis, as I've said, the stock is going to move with oil and gas industry news. Especially oil, which is bizarre, but oil gets the gets the headlines. If something's going on with oil prices, it's going to affect the daily movement of Chart's ticker. So don't be surprised if you see a fall 5% one day when oil prices are up or down, or a gain 5% on some oil news for no reason, you can't find anything material in any headlines about Chart. You're just going to have to be resigned to that just being the reality.
What you want to focus on is, you look at those financial targets. They say they want to grow margins 700 basis points. They want 21% of their sales to be coming from those aftermarket services. They want revenue to be up 40%. What you want to do is, every time there's a quarterly report, you want to look at it. Are they showing incremental improvement? Moving toward those metrics? Or are they giving us excuses why they're not doing it, or talking about some change in strategy? You want to use your BS meter to measure what management is saying against what the company is doing.
I have to say, I've been very impressed with their new CEO. She's done an incredible job of leading the company from an operational perspective, continuing to focus on those things to leverage -- like that $7 million charge this quarter that's going to put more operating income on the bottom line as an example. I think, as long as you see those kinds of things happen, if those are the unexpected things we see happening, then the sky's the limit.
I think it's worth owning. Again, focus on the incremental things. Focus on how it's talking about the growth of the backlog, and excuses vs. execution. That's how you measure the company.
Sciple: Yeah. I've said this before for a lot of different cyclical companies, I think this company is along the same lines -- you have to keep in mind the long-term trend that you're investing in with this company. Over a long period of time, it appears to be more likely than not that LNG becomes a more significant contributor to global energy output. Chart is going to be a part of that. Now, in the near term, there's anything that can happen that's going to fluctuate stuff over weeks or months or even a year or so. But what you need to pay attention to is that the company's executing on what they said they were going to do, and that the long-term trend on LNG is intact. If it is, then I think the thesis behind this company is quite bullish.
Jason, I know you own some shares of this company. Should investors think about buying this today? What are your thoughts on it at this current level?
Hall: I don't remember exactly when I bought last, but I have bought some time in the past 60 days. I think it is worth buying right now. You mentioned Jim Mueller earlier, one of the great analysts at Fool HQ. To quote Jim, something he's talked about is, if you buy a lot and it goes down, you don't lose a lot. But if it goes up a lot, you don't need a lot. [laughs] It's a great stock that you can buy a small starter position, learn more about the company, follow it, and then if there is a big decline, you will have had an opportunity to learn whether it was the thesis just blew up and something happened that it's not worth investing more in; or it's way down and now it's an opportunity to really go after and buy more. Or, if it just goes way up, and you follow the thesis, and you're like, "Well, there's all this enthusiasm, but the company's not delivering results," and you decide you're ready to move on, you can move on at a profit. Or, you can say, "Things are still going great. I'm going to hang in there. I really like this business."
I think it's a great one that you buy incrementally vs. just throwing your money out and ignoring it. You want to continue to follow the story because of the cyclical nature of the business, looking for opportunities to buy more if the opportunity is there, or to move on if the thesis blows up.
Sciple: Yeah. Just a note, this is a company that we've recommended at The Fool here more than once. I'm confident in it. But, as Jason said, this is a classic example of a company you want to buy in thirds or sixths. Really spread it out over a period of time. Pay attention to the company, continue learning it, follow the trends. If you dollar-cost average, buy in chunks, you're going to smooth out any of that volatility.
Jason, thanks so much for coming on once again! I always enjoy having you and look forward to having you on again soon!
Hall: It's good to be on! What should we talk about next? Have we talked about home builders? Maybe we should talk about home builders at some point.
Sciple: Yeah, I'm up for it! Listeners, if you've got anything you want us to talk about, tweet us, @MFIndustryFocus. You can also tweet me, @NWSGator. You can tweet Jason, @TMFVelvetHammer, on Twitter. If you have anything you want me and Jason to break down for you, tweet us at one of those places and we'll see what we can set up for you.
As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for his work behind the glass! For Jason Hall, I'm Nick Sciple. Thanks for listening, and Fool on!