Chart Industries, Inc. (GTLS) Earnings Call Transcript & Summary

All right. Good afternoon, everyone. Hopefully, everyone's well fed, and we are in the home stretch of the conference. And hopefully, everyone is having a good time. We have Jill Evanko with us, President and CEO of Chart Industries. Thank you for taking the time for us.

Thank you for having me.

Jill, I know you wanted to get through some slides, so I'll turn the floor over to you.

Yes. Thanks, Adi. So what we thought we would do today in this deck was released this morning, so you should be able to access it either via the 8-K or on our website, was run through a select few slides to provide an update on our signed transaction for the acquisition of Howden and provide some updates since we announced that in early November. So I will go ahead and get started here. We'll have the standard forward-looking statements and we'll skip those and get going here on a quick overview of the transaction itself. So on November 9, we announced a definitive agreement to acquire Howden for $4.4 billion from KPS Capital Partners. You can see the multiples listed in the top part of the slide with [Audio Gap] $475 million, the pro forma 8.5x EBITDA multiple. We're very excited about the synergy opportunities, which come from the combined business versus just one business going in and taking costs out of another. And there's an enormous amount of commercial synergies as well, which I'll talk through in the coming slide here. Since the transaction was announced in November, we executed our permanent financing plan, which was via the debt markets as well as secondary issuance of common equity and mandatory convertible equity issuance, and that was completed at the lower end of our anticipated weighted average cost of debt range of 7% to 8.5%. The timing of the closure for the acquisition is still anticipated to be in the first half of 2023. What is remaining here are customary closing conditions with the regulatory filings, all having been completed, as of December of 2022. And so those are well underway for us to have confidence in continuing to expect the transaction to close in the first half. When you look at the transaction itself, it is continuation of our playbook that we've put in place to leverage our equipment, our process technologies into specialty end markets, diversification of what we call the Nexus of Clean. So clean power, clean water, clean food and clean industrials. The Howden combination with Chart brings us further access to more addressable market in markets such as hydrogen, such as water treatment, carbon capture and storage to name a few. In addition to that giving us access to new renewables end markets including energy recovery, nuclear and biomass, just to name a few. So it's an expansion of our addressable market for specialty, which I'll get to in a moment here as well as an expansion of the types of end markets that are looking for full solutions in the renewables end markets. We're also thrilled with the access to new geographies, both from a manufacturing footprint perspective in places like Africa, additional manufacturing in India as well as access to markets like South Korea and Chile, which are heavily renewables focused. So I'm going to continue on here, and I'll come back to a couple of the points on those 3 inorganic investment principles in a moment. One of the things I want to step back. This is not a new slide, but it's an important slide, is that both Chart and Howden are very different businesses than they were 3 or 4 years ago. And we went through that transition in the public domain. So those who have followed Chart for the last 4 or 5 years have seen our strategic pivot. For Howden, that happened under private equity ownership. And so there's information here that has happened in a very similar transition to what we did, but it happened in the private domain. So I want to spend a little time today just talking through what those elements of the strategic pivot were. But on this slide, I'm going to touch on just the last row here, and this is meant to be illustrative, or [lustrative], as someone told me earlier today is the right way to say that word. And it's -- but it's an important point here. What that is, is if you take each of our respective businesses, traditional equipment, so let's take brazed aluminum heat exchangers for Chart. Historically, those were used primarily in midstream, upstream, downstream oil and gas applications. Those same brazed aluminum heat exchangers are what are used in hydrogen liquefaction, helium liquefaction, small-scale and floating LNG. They're used in a variety of different water and carbon-capture applications. So when somebody says, well, you're a different business than you were 4 years ago. Well, that is exactly the same thing that Howden has done in their strategic pivot. So you can take a piston or a diaphragm compressor. And those were traditionally used in refinery applications. Those same compressors with some tweaks are used in what we call the Nexus of Clean applications and used in hydrogen compression, as an example, where they are a leader with over 3,000 compressors for hydrogen installed around the world today. So for those of you who have followed the Chart story, you've seen this slide before. We went from being heavily reliant on 1 large project over the course of the cycle, very non-repair and service aftermarket oriented. As a matter of fact, 5 years ago, we had no revenue related to repair and service and aftermarket, and also not very sticky with our customers, heavily concentrated to industrial gas majors, and you've seen us pivot to what is on the right-hand side of this slide. So Howden's private transformation was very similar, where they've been able to penetrate an installed base with digital uptime offering, which gets the access to long-term service agreements, now comprising 48% of their revenue in aftermarket service and repair at meaningfully higher than average gross margin as a percent of sales all the way through to some of the cost rationalization in manufacturing, where you build what very similar to what Chart has done. So I won't walk through every point here, but the takeaway being that the strategic pivot and the execution of that strategic pivot that you've seen the Chart business go through over the last 4 to 5 years, Howden has done the same thing. So in this combination, I've talked about the commercial opportunities, the access to more first-of-a-kind, including, for example, Howden being on the first e-methanol plant, the largest e-methanol plant, having equipment at the world's largest hydrogen refueling station to do -- to also doing clean and decarbonization for the marine end market. In addition to that, this doubles our engineering skill set in engineering head count in the Chart business. That's something that is super important when you're looking at offering a full solution with process technology and equipment. And why is that so important? When you're talking to folks that are doing renewables projects, it doesn't matter what the end market, end use is, you have to be able to help them design that facility design that use. And that requires a certain skill set of highly skilled engineers that are familiar with both stationary and rotating equipment that work together to be able to produce this outcome. There's 3 points I'm going to make in this section here. The first I've touched on at the outset, which is the expansion of our addressable market in the Nexus of Clean, and that's both through expanding our existing markets with more content as well as bringing us into markets that are focused on decarbonization. Great examples of that are marine. Another great example of that is mining where these are CO2 emitters. And they're moving towards decarbonizing their own operations, whether that's through CCUS or in the case of Howden, VentSim application, which helps monitor and optimize how equipment and energy usage is happening. The second point I would make is the combination reduces our customer centricity. So at Chart, one of the things that you've seen us do is work to be more global in our customer base. Get new customers. In 2021, we booked orders with over 400 new customers that hadn't done business with us before, and we'll share on our February 24 earnings call, that same metric for 2022. So all of that has been meant to get away from high customer concentration with our top 10 folks. If you look at the last few years, where over 30% of our revenue is with our top 10 customers. And a portion of that is related to our industrial gas customer base and a portion of that is -- as we do more small and midsized projects, those tend to become a larger portion of your revenue in any given year. So Howden is the opposite. There's no customer that has more than 4% of their revenue. And when you look at the top 10, it's certainly, historically, less than 15% of the total revenue. But we also [Audio Gap] while there are some overlapping customers, there's [Audio Gap] in both directions for pull-through of our respective equipment and technologies. When you talk about, take a customer like Shell, both Chart and Howden historically have done business with Shell. In the case of Chart, it was primarily downstream, midstream, upstream oil and gas. And in the case of Howden, primarily around the refining side. Both of us have had the opportunity to work with the international oil companies as they've started on their journey of sustainability and moving toward more ESG-oriented solutions. And what the capability of having that history with customers and bringing the offerings together has allowed each company to do is continue to build on that relationship. And customers like Shell, where Howden did their red to green project of moving to a cleaner refinery and biofuel oriented applications. That's a great example. Chart, we serve them with LNG fueling stations as an example. Now bringing those 2 together just gives us a greater opportunity to work with existing customers on a broader sustainability journey. So I want to talk just for a moment on the reduction of cyclicality that the combination brings into the Chart business. So to orient you on this slide, from left to right, you see the columns of what we look like as a company on our own for the decade of 2008 to 2018. The middle column where we sit as of the end of the third quarter of 2022. And then the final column on the right-hand side of the slide, the combination and what it does for us. So row 1, we went from being heavily oriented to oil and gas and industrial gas in the decade of 2008 to 2018 to the point of current state about [ 58% ] of our business related to industrial gas and traditional energy. And then the combination will reduce that even further. Row 2 is around heavy reliance on that 1 or 2 projects. So I commented on that on an earlier slide. We have gained traction on the small-scale side and generated more and more opportunities to have not just 1 project driving the growth in the business. And with Howden, we'll continue to have more project business from having the combination of the full solution but also they have a more book- and ship-related business. So that will be a very nice balance. The aftermarket service repair is critically important to reducing cyclicality. We were at nothing 5 years ago. We're about 13%, 14% of our revenue today. And our goal was to be above 20% in a couple of years on our own. This combination gives us 31% of total revenue in the combination related to aftermarket service and repair with gross margins of 42% plus. If you think about that, look at the repair service leasing, RSL segment of Chart, and our segment runs in the mid-30% gross margin as a percent of sales. So to have the combined business be over 42%, that indicates that Howden has a stronger ability to command margin in the aftermarket service repair side, which is the result of not just the 41 locations around the world, but also the digital uptime offering and the VentSim offering as well. The U.S. versus international mix in the business, we have worked at Chart over the prior years to diversify away from North America being so heavy as a percent of our revenues. That's come both organically and inorganically through the actions that we've taken. If you look at 2016, 2017, 70% of Chart revenue was in North America. And today, we're about half and half. That will continue to be in that range in the combined business with a broader geographic manufacturing footprint. So that's the meaningful move forward. And then lastly, the LTAs and LTSAs are really important when you're talking about looking at growth across the cycle. So I talk specialty, and specialty is comprised of a variety of different end markets that are ESG, sustainability linked. And in the last 60 days, you can't open your news feed any day and not see something around clean. And these next 2 slides, and I won't go through everything here, are just around the last 60-day announcements that have come out from both the public and the private domain. As recently as this week, where India announced that they have a green hydrogen -- a national green hydrogen mission that's going to dedicate $2 billion of public funds in the next 6 years to hydrogen, specifically. And both of our companies are very well positioned in that region. I won't run through everything here. You can go through these slides on your own. If you desire to do so, outside of the last point on this page, in particular on the nuclear side of the house where Howden works with ITER with a variety of different nuclear customers, and there's a great opportunity to pull Chart's vacuum jacketed pipe as well as our helium refrigeration cycle through 2 nuclear fusion applications. And that's another area similar to marine and similar to electrification, where having a good relationship with your customer base is a way to -- is the key to bringing more content to those folks. So this is not a new slide. This has been out there before, but I think an important element to kind of look at the new build component of energy transition and renewable related and industrial and traditional energy. So I did walk you through those figures already and happy to take questions on that. Now this slide is a new slide today. This is our near-term specialty total addressable market. When we refer to near term, we're referring to now through 2026, and there's a meaningful increase as well from 2026 to 2030. On our earnings call on February 24, we will put out the 2030 combined total addressable markets. The way that we do this is from the bottoms up. So we build it based on commercial pipelines, based on applications not just taking a worldwide TAM and applying a percent of -- we should win that. So this is really a bottoms-up build. And what you can see here is through the combination, we more than double our near-term total addressable market, and about half of that is related to hydrogen, which we're very excited about the combination, both companies being leading players in hydrogen with over 160 years of experience. What I would say on this is it's really important that you remember that in the hydrogen world, it's going to be both gaseous and liquid. And Chart on our own, we had very strong access to the liquid hydrogen market, and we're the leading player in that but very limited access to the gaseous hydrogen side of things. And there's an enormous amount of content that is being built this decade in the gaseous hydrogen side of things with the opportunity to pull through Chart equipment. So both companies are leading players in the market with strong installed base, and that's an extremely important decision point for customers when they're going to do a hydrogen project. Do you have something out there that is working that we can go and see and Howden has over 3,000 of their hydrogen compressors out there in the market. We have about 1,000 of the liquid hydrogen tanks, and we're the leader on the hydrogen transport and storage. And then lastly, both of our companies, respectively, issued 3 new products into the hydrogen market in the last 3 years, which is certainly a leading position in being able to do that and have it work and have it accepted. So the combined offering together brings us more access to gaseous than we would have on our own, but also the combination of pull-through to a production facility all the way through to end use is extraordinarily important. And what we believe you're going to see over the course of time is that there will be more pipeline use for hydrogen, whether that's blended with natural gas or whether that's pure-play hydrogen pipelines. And having the Howden offering is really going to be critical to being able to play in the distribution network of hydrogen going forward. So I'm going to wrap up here in the next couple of minutes, but I wanted to include this particular slide, which is probably my favorite slide because I think it exemplifies how Howden plays in the Nexus of Clean. You hear me regularly talk about our wins related to clean power, water, food and industrials. And so I thought I'd spotlight some of Howden's wins from the second half of 2022 ranging from their work with INOVYN or INEOS on hydrogen in Romford, United Kingdom to winning multiple water treatment projects, including the Tuas Water Reclamation project in Singapore. They also won the water treatment work for Frankfurt, Germany, all the way through to the nuclear project that I already referenced. So these are good examples of the ways that Howden plays in the Nexus of Clean, very similar to how we do. And every single one of these shown on the screen, and I would say every single one that isn't shown on the screen, but you can go on their website and see, would have the potential for Chart content. And the same would be in reverse when you look at our first-of-a-kind in our projects in these markets. These are -- the cost and commercial synergies are not new slides. So these are the same slides that are out there. I'd reiterate that the 2 teams work together, built these bottoms up. We have a high level of confidence in both the cost and the commercial synergies. From a cost perspective, one of the comments that I've heard is, well, this is a private equity-owned business. So how is there more cost to go after? Well, the cost comes from the combination of the 2 together, not from Chart going in and just cleaning house on the cost side of Howden's business. And that ranges from indirect spend to in-sourcing of compression that we currently buy out from other providers to indirect spend to the direct sourcing side of things. We have the top 5 combined usages of metals, plates, instrumentation and industrial fittings is a real meaningful spend when you put the 2 together. And what I would tell you, and I'll tell you in a minute, is as you're starting to see input costs come down, you combine that with a supply base that was very well benefited over the last couple of years in challenging supply chain times. Those 2 things together with the power of volume really lend itself to this being a strong time to go in there and get early day synergies. And on the commercial side -- I can go on and on, on the commercial side. So you've already heard me. I'm not going to repeat those here. I'd be happy to go into detail with anybody who's interested. The digital offering is super important here. There's a couple of case studies in the deck that we put out this morning around how uptime works and around how VentSim works. But the upshot of uptime is that it monitors so that you don't end up with a catastrophic failure and you have to replace the equipment. So that monitoring and that data from a preventive maintenance standpoint is something that has saved customers millions and millions of dollars by having the uptime enabled and there's a meaningful installed base that does not yet have it. VentSim is around CO2 emitters in monitoring CO2 emission, but also optimizing energy usage. And so doing in the optimization of energy usage, save customers money. One case study saved customers $3 million just on when fans were running in a particular mine application. So this brings us numerous opportunities on aftermarket service and repair, and just coming out of the gate being in a combined position of over 30% of our revenue in that space at higher margins is a nice benefit to the financial outcome here. And so in December, we completed our permanent financing debt raise and secondary issuance. And as I commented to the outset, we were at the low end of our weighted average cost of debt estimates as we headed into that. You can see the capital structure here. This is a new slide to provide you that level of detail for modeling purposes in particular as well as targeting to get drive ourselves back into our 2 to 2.5x net leverage ratio range coming out of 2024. I would point out that we have announced that we are going to divest 2 businesses, noncore businesses from the combined offering, and we are underway right now in conversations with buyers for those too. Those numbers and those potential proceeds are not included in what you see in our numbers for free cash flow generation or for debt paydown or net leverage ratio that are in any of these slides. And message heard, no one likes free cash flow conversion that has been eliminated from our deck. That was a banker usage here. So we're providing our current view. This is 2023 pro forma for free cash flow generation and ability to utilize cash for debt paydown, which is in approximately $450 million range after you walk these particular items. We use a 19% tax rate. We think that there's an opportunity to get that closer to the mid-teens level. And there's actions that we haven't disclosed in the public domain around how we're going to be able to accomplish that. So plenty of opportunity, and we're reiterating the financial policy that we stated verbally back in November, reiterating that at the bottom of this side around not doing material acquisitions or share repurchases until we're in the target net leverage ratio range that we have put out there. And I include an ESG slide that points out, we will continue to drive to our ESG targets that Chart had previously put out, which was a 30% CO2 emission reduction by 2030, and net carbon neutrality by 2050. I would point you to the middle of the slide where Howden had more aggressive targets to get to carbon neutrality by 2035. In the combined business, we will continue to drive to the Chart previously iterated targets. And last and completely unrelated to the Howden transaction, but an important point here that we've been getting a lot of questions on, and we'll go into more detail next month is our input costs. What's happening in the supply chain? Our top 3 input costs; aluminum, carbon steel, stainless steel. We are seeing tempering in the costs related to those 3, and we're seeing continued increase in availability of these materials. LME as a whole, we expect to continue to see a downward trend across this year. And when you look in the upper right-hand corner there, carbon, steel, that's the lowest it's been since mid-2020. And then hot rolled plate at the bottom left corner is the lowest it's been since mid-2021. And then the last chart there is freight, global freight costs. So you see that continuing to come down, and we continue to be neutral on freight cost and pass through to our customers. So the setup from a macro perspective in terms of the supply base is strong as we head into -- strong in our favor as we head into 2023. All right. I think I ran over Ati.

Thank you for the additional clarification. Jill, it's been 2 months since you've had these conversations with investors at this point. What do you think is well understood, what do you think is underappreciated about the transaction about the story as it stands today?

Yes. So I think that what's well understood is -- and we've gotten very little pushback on is the strategic industrial logic of the combination. So understanding how the 2 businesses fit together like puzzle pieces. In terms of getting past the permanent financing actions in December, I think that was a meaningful catalyst as we headed into 2023, and it was important that we got it done in the range that we had indicated in our assumptions around modeling purposes. When you get into things that I think will continue to require more information and education, the #1 item being people remember the business as it was when it came out of Colfax, and went into the private land, as I described, and did -- went through the same pivots that we did, but people didn't have the opportunity to see that unless you were in the industry. And so I think it's important that we continue to explain how that pivot has transformed the business. And then around kind of our ability to -- in the combined business continue to grow at double-digit plus range, and we have a high level of confidence and conviction in being able to do that. And delivering the cash for the debt paydown. So a lot around our continued conviction. Our conviction is even stronger because we've seen them in the last 60 days. But with that said, I think a lot of this is the catalyst to get to close, and then from there, the execution against what we think are very achievable targets.

You spoke about the deleveraging. As you think about -- I wanted to touch on the cost of capital a little bit. So the cost of debt obviously came in a lot better than what most investors were fearing. But as you went through the process of putting the -- putting the debt together, thinking about the preferred shares and raising equity, talk about that thought process there. And why the decision to raise equity and not do the preferreds versus keep the preferreds? Just any color there.

Yes. So as we look at the convert preferreds, when we signed the transaction, both bridges and the convert preferred were meant to be backstop financing. So we had a plan that we were going to continue down the path between signing and closing for the permanent financing, which we did. And our thought process was that it would be okay to have the convert preferred at a smaller portion, but we didn't want it at that large $1.1 billion number for multiple different reasons. And in particular, because we didn't want a preferred share class that was hanging out there at that level, and we wanted the ability to have the stub convert into common, which we had a certain level associated with it. But ultimately, we felt that this was a very clean way to go about it and have -- and set the stage for us to be able to continue to pay down debt and do so in a way that didn't have any yield hanging out there beyond our debt structure that we laid out today.

Got it. And then when you have about 7.5% cost of debt, obviously, the cost of equity changes a little bit. I think a lot of investors are trying to figure out what the clearing event is to try and change that cost of equity. How do you think about that? Is it quarter-to-quarter basis? Or is there a specific event that you would point investors to?

Well, so we think of our business as an ongoing business, right? So it's -- for us, it's not a quarterly type of event. I realize I say that until I'm blue in the face every quarter, that is -- our business isn't a 3-month business. But what I would say is that every day, every week, and we can't obviously talk into the public domain that frequently. But the things I look at -- and we look at as we run the business are around, are we continuing to see the demand out there? Are we continuing to get the gross margin back in levels that are 30-plus percent? And that's in the combined business, even more so in there. So the execution elements and that is something I'd look at on a quarterly basis. I'd also look at this point, the next, in my opinion, catalyst here between -- and the Howden transaction is really the close. So at this point, we're talking about the regulatory filings that have been completed and getting those across the finish line so that we can close. I think watching the 2 divestitures post close, that is additional cash inflow, helps to reduce that debt faster than what we've laid out is something to watch for, and it would be a good catalyst as well. But ultimately, this is the combined business and is driving what is an unmatched and unparalleled combination and showing that people need that combination, want that combination, and we're executing the financials against it, certainly, really makes the growth that should be there acceptable.