The Realities Of The LNG Market Weigh On Chart Industries

When I last wrote about Chart Industries (GTLS), one of concerns about the company's high-flying valuation was that there was a real risk of disappointment if the rollout of LNG vehicle fuel infrastructure hit any bumps in China or the U.S.. That is exactly what's happening, and the consequences for Chart's stock price have not been pretty.

Chart's ability to manage large-scale Energy and Chemical (E&C) projects need to improve, but a lot of what will drive this company/stock is outside of management control - truck builders, fueling station builders, and LNG liquefaction facility builders seem stuck in a cycle of "no, you first". I do believe that LNG as a vehicle fuel makes too much sense not to happen and that Chart Industries shares hold some appeal now for long-term investors, but the stock really needs better reported order growth to get moving upwards again.

Orders Don't Inspire

As a momentum story, Chart Industries needs to continue to show strong revenue and order growth. For a variety of reasons, that is not happening right now.

Revenue for the fourth quarter was flat, missing the average sell-side guess by about 6%. E&C revenue fell 17% due to customer delays with large LNG projects, while Biomedical revenue fell 13% as the home respiratory care industry reconfigures itself in the wake of Medicare reimbursement cuts. Distribution and Storage (D&S) was up 18% this quarter, which was pretty good relative to most expectations.

Margins definitely improved, although the details were a little messy. Consolidated gross margin rose almost three points, but both E&C and D&S saw slight year-on-year declines offset by a big increase in Biomedical. Operating income rose 21%, with operating margin up almost two and a half points on improvements in all the segments.

While Chart's better-than-expected margins definitely softened the blow of the revenue miss, it is orders, not margins, that investors really crave (unless/until margins disappoint, then that will matter again … dontcha just love Wall Street sometimes?). Orders fell 22% sequentially, with a large drop in D&S (down 33%) augmented by single-digit declines in E&C and Biomedical. More on this in a moment, but it drove backlog down 2% sequentially and to around 2.5 quarters of revenue.

Problems Over There...

One of the principal issues for Chart right now is a potential slowdown in its Chinese D&S business. Chart is one of the leading suppliers of storage, packaged gas, cryogenic, and LNG fueling station models for the LNG vehicle fuel station market. Growth here has been torrid, driven by China's desire to control pollution, with the number of LNG stations more than doubling from 2012 to around 1,300 in mid-year 2013.

Problems have emerged, and they are impacting Chart's business. First, issues of natural gas supply have led to a slowdown in plans for new stations; China is moving aggressively to expand its supply of natural gas and LNG, but it takes time. Second, Chart's largest customer Petrochina (PTR), which operates almost half of the country's LNG fueling stations, is enmeshed in a corruption probe and pulling back on some of its operating expansion plans.

… And Problems Over Here

Chart is also seeing a slower-than-expected development of LNG markets in the U.S.. While most parties seem to agree that making more use of natural gas as a fuel makes good sense, nobody is moving forward with any particular urgency.

LNG can be used to fuel oil and gas drilling rigs, saving more than $600,000 a year in operating costs on average, but less than 10% of the U.S. fleet runs on it today. Rail could be a major consumer of LNG, but General Electric (GE) and Westport (WPRT) are moving slower than expected here, reducing Chart's immediate opportunities to build tender cars.

Heavy trucks are the biggest opportunity in the U.S., and here too it has been a story of frustration. The press on the Cummins Westport engines (a venture between Cummins (CMI) and Westport) has been good, but adoption has been slow due in part to concerns about natural gas prices and LNG availability. Plans to build small-scale LNG liquefaction plants are being held up financing issues related in part to concerns about a low number of LNG fueling stations and trucks on the road, and companies like Clean Energy Fuels (CLNE) are getting less ambitious on building new fueling stations because of lower than expected numbers of LNG truck purchases and LNG supply concerns.

That logjam is bad enough, though I do believe that expansion of LNG capacity in this country (both production and distribution) is a "when, not if" question. The more pressing concern could be the migration of some of Chart's Chinese competitors into the U.S. market - threatening prices and market share in a market that hasn't even gotten going in earnest.

Is Growth Still "When, Not If"?

Most of the "LNG economy" stocks (Chart, Westport, Clean Energy) have gotten knocked on their butts since the fall of 2013. It's probably not just coincidence that that is about the time that natural gas stocks like Ultra Petroleum (UPL), Chesapeake (CHK), and Southwestern (SWN) started moving. Longer term, though, I don't believe it's an either/or situation - the recent jump in natural gas prices might have caused some sticker shock and reminded people that sub-$3 gas isn't the long-term norm, but I don't believe higher gas prices derail the long-term advantages of greater LNG adoption.

Assuming that petrochemical companies will continue to build LNG plants to supply Asia's growing demand for natural gas (and perhaps rising demand within the U.S. as well), and that vehicle fleet operators continue to support a long-term shift toward LNG, I still believe a mid-teens long-term revenue growth forecast for Chart is reasonable. Likewise, I believe Chart can lift its FCF margins back toward 10% over time.

The Bottom Line

Chart Industries still isn't exactly cheap by current EV/EBITDA metrics, so you have to buy the idea that this is a story with considerable growth in its future. Raising the discount rate on Chart to account for this logjam in the U.S. market drops my fair value to around $95, but that's still enough potential to make this stock worth another look.

As the wind and solar markets have shown, there can be enormous volatility and shakeouts as these markets develop, and now that has come to the LNG market. There's no way I would recommend Chart to an investor who panics when a holding has dropped 10%, but for the risk-tolerant readers looking to play "the next big thing", keep an eye on Chart's orders and keep the stock on a watch list.

Source: The Realities Of The LNG Market Weigh On Chart Industries

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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. (More...)

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