Hudson Technologies, Undervaluation Unlikely To Last
I am rating Hudson Technologies, HDSN 0.00%↑ , a Strong Buy based on valuation and balance sheet strength. The company stock has been beaten down this year and is available at a discount. It can currently be bought at 8.1 times earnings and 0.3 Price to Earnings Growth, which is significantly below its peers. Additionally, the company is projected to grow its sales by 18% next year with an expected EPS growth of 35.1%.
The stock price has declined 28% over the previous 52 weeks. I attribute this decline to lower commodity prices (refrigerants) and 11% decline in revenues and a lower gross margin in 2023 compared to the year before. The EPA rule change phasing down the use of virgin HFC and promoting the increase in use of reclaimed refrigerant is one reason why the selling price has been under pressure as the companies work to reduce their inventories.
Hudson Technologies is an American industrial products company and operates in the Specialty Chemicals industry. It is a full lifecycle product and services provider for commercial refrigeration. This includes Sales, Reclamation, and Recovery services for refrigerants. They also consult and provide management services for CO2 avoidance tracking and maintaining optimal chiller and plant performance (R-Side Service).
It is one of the largest refrigerant reclaimers in the country. It recently purchased US Refrigerants, a national refrigerant distributor and purchaser of recovered refrigerants, paying 6x EBITDA for the acquisition, which is in line with its internal targets for acquisition multiple.
The company has a market capitalization of $359 million and a current stock price of $7.89 per share. The stock price is down 41.5% YTD and 8.6% in the last 1 year.
Financial Overview
Earnings Trends
In the last 10 years, the company has grown its annual revenue at the CAGR of 18.2%. Its Earnings per share has grown at the rate of 25.3%, while Net Income has gone up by 30.3%.
It is a growing company with cyclical economics. There has been share dilution over time but the capital has been employed efficiently to improve the earnings per share. Its TTM P/E ratio is 8.1 which compares well with its competitors and industry (40.6). Net margin is at 16.7% compared to 5.3% for the industry.
Balance Sheet Strength
Hudson Technologies acquired Airgas Refrigerants Inc. in 2017 for $220 million. This was the largest acquisition for Hudson till that date and resulted in a significant debt load. The company has been paying down its debt burden since then. Total liabilities have gone down from $198 million at the end of 2017 to $68 million at the end of 2023.
10-year growth in Shareholder Equity is at 19.3% CAGR. On a TTM basis, the company operates at a Return on Assets of 15.8%, Return on Equity of 19.4% and ROIC of 21.6%, all of these are significantly above the industry average at 6.5%, 14.4% and 8.8% respectively.
Recently Hudson Technologies acquired USA Refrigerants Inc, for $20.7 million. The company certainly has the balance sheet strength to pursue further acquisitions and has shown the ability to successfully integrate and grow as a result.
Long-term debt/Equity is close to 0.
The stock currently trades at 1.5 times book value, which is within its historical range. The industry average is 2.7 so the stock is trading at a discount to the peers.
Cash Flows and Liquidity
2023 Free cash flow amounted to $55 million. The company has grown FCF with a CAGR of 48.4% over the last 10 years. There is no dividend and the interest coverage stands at 10.2. With a current ratio of 4.3, there is no concern about the company being able to meet its short term cash needs.
Investment Thesis
The primary reason for current stock price weakness is the HFC rule change by the EPA and how it is affecting the demand/supply dynamics in the refrigerant market this year.
In its Q1 earnings report, the CEO Mr Brian Coleman noted:
“As we have often mentioned, our selling season comprises nine months, and we believe the 2024 season will provide us with enhanced visibility around the ongoing HFC phasedown and corresponding supply/demand dynamics as we navigate the 40% stepdown in virgin HFC production and consumption. Additionally, the EPA’s proposed Refrigerant Management rule is expected to be finalized in late summer and includes proposed language mandating the use of reclaimed refrigerants for certain applications and equipment. While 2024 may not unfold as favorably as previously expected, it is important to reiterate our confidence that the phasedown of HFC will ultimately move pricing higher, accelerate reclamation adoption and drive enhanced profitability in our business. With our industry leading reclamation technology and established customer network, we believe Hudson is well positioned to benefit from the continued implementation of the AIM Act as virgin HFC refrigerant production and consumption is reduced and the industry begins to rely more meaningfully on reclaimed refrigerants to service the existing installed base of cooling and refrigeration equipment.”
I expect that by 2025, the demand and supply equilibrium will be reached and the profitability and consequently the stock price will improve.
In the previous 10 years, the stock has traded as high as 23.6 P/E. Its peers in the Specialty Chemicals industry are currently trading at higher P/E than HDSN. For example,
While these are not direct competitors to Hudson, this does give us the current sentiment in the market around companies in this industry.
Valuation
With its growth focus and acquisitions strategy, and potential for improved economics in 2025, it is reasonable to expect the earnings multiple to expand to 15 from the current 8.1. This is approximately an 85% appreciation for a projected price of $14.61/share. it was trading at these price levels in Feb/Mar of this year, so it is not an unreasonable ask. The stock closed 2023 at price of $13.49 and a P/E ratio of 12.1.
As of 8/4/2024,
My thesis is primarily based on potential recovery in pricing and multiple expansion.
By some accounts, the company now has 35%+ market share of commercial refrigerants in the US. The acquisition of the USA Refrigerant is another example of the company acquiring productive assets during a weakness in the market, which augurs well for the company to grow its market share in the coming years.. On every valuation metric, the company appears to be solid. Hotter summers should keep the coolers humming and demand firm for their services.
Conclusion
HDSN 0.00%↑ stock is a Strong Buy at the current prices. The temporary price change is related to EPA rule change that has caused a temporary excess supply of refrigerant in the market. This excess inventory should work off this year, and the resulting increase in reclamation and recovery business should cause the Price/Earnings multiple to recover to what it was earlier this year, or even better as the company is also growing its market share.