GENERAL ANALYSIS
Company description
Hudson Technologies, Inc. was founded by Stephen P. Mandracchia and Kevin J. Zugibe on January 11, 1991, and is headquartered in Woodcliff Lake, NJ. It operates as a refrigerant services company, which provides innovative solutions to recurring problems within the refrigeration industry.
Its products and services are used in commercial air conditioning, industrial processing, and refrigeration systems, which include refrigerant sales, refrigerant management services consisting primarily of reclamation of refrigerants, and Refrigerant Side services performed at the customer's site to remove moisture, oils, and other contaminants. The company also offers predictive and diagnostic services through the Chiller Chemistry and Chill Smart brands. Hudson has proven, reliable programs that meet customer refrigerant needs by providing environmentally sustainable solutions from initial sale of refrigerant gas through recovery, reclamation and reuse, peak operating performance of equipment through energy efficiency and emergency air conditioning and refrigeration system repair, to final refrigerant disposal and carbon credit trading. The Company’s operations consist of one reportable segment. Its mission consists in providing products and services that reduce greenhouse gas emissions, increase energy efficiency, and promote sustainability to encourage understanding and ensure future generations inherit a healthy planet. It is one of the only companies to provide on-site refrigerant services on a nationwide basis and the industry leader for RefrigerantSide® services in emergency situations. RefrigerantSide® services consist of system decontamination to remove moisture, oils and other contaminants intended to restore systems to designed capacity. The Company is a leading provider of sustainable refrigerant products and services to the Heating Ventilation Air Conditioning and Refrigeration (“HVACR”) industry.
Industry Overview and Competitive Positioning
The heating, ventilation, and air conditioning (HVAC) technology provides environmental comfort through thermal manipulation (heating and air conditioning) and acceptable indoor air quality (ventilation). Sometimes refrigeration is also included in the field as HVACR. In 2022, the global HVAC market attained a value of nearly USD 159 billion. Furthermore, forecasts estimate the global HVAC market will grow to $227 billion by 2028. The HVAC industry in the USA is a major economic driver. HVAC companies generate $150 billion in annual revenue and employ over 1.5 million people in the U.S. The HVAC industry is expected to continue to grow at a CAGR of 6.1% from 2021 to 2026. Each year in the U.S., over 3 million heating and air conditioner systems are replaced, and $14 billion is spent on HVAC services or HVAC repairs.
HDSN is good value based on its Price-To-Earnings Ratio (10.1x) compared to the US Trade Distributors industry average (11.3x). One of Hudson's key strengths is its strong financial performance, with it dominating competitors when it comes to operating statistics. The company's LTM EBIT margin of 42.4% is well above the average of its direct competitors (4.87%) and its LTM gross margin of 52.2% is also significantly higher than its competition (21.2%). These strong margins have allowed HDSN to generate a net income margin of 33.3%, which is again higher than its direct competition of 3.7%. Hudson's closest competitor when it comes to operating statistics, is Watsco, Inc. (WSO). Watsco still falls short of Hudson in these four categories but has a respectable 27.9% LTM Gross Margin as well as both EBIT and EBITDA margins over 11%. Some other notable competitors include Transcat, Inc. (TRNS), CCOM Group, and NOW Inc. (DNOW), which also come up short of Hudson. Given its high growth and low debt, HDSN also has several opportunities for future growth. One opportunity is the potential to expand into new markets, either through organic growth or through strategic acquisitions. The company could also potentially capitalize on any shifts in consumer preferences towards more energy-efficient products.
FINANCIAL ANALYSIS
Introduction
In this section of the analysis, we will conduct a comprehensive assessment of Hudson Technologies' financial statements and performance metrics. This in-depth examination will enable us to assess the company's historical and recent performance, thereby facilitating the acquisition of valuable insights into its future prospects and investment potential.
Optimistic Outlook for HDSN
Two projections for the global refrigerant market. One is estimating a CAGR of 7.4% until 2030, the other a CAGR of 7.98%. The global refrigerant recycling market is projected to witness a CAGR of 10.5% through 2028. As the global equilibrium temperature shifts, it can be expected for the HVACR industry to witness elevating demand for decades to come. When examining positive feedback loops, changes in output lag their underlying causes. So even if greenhouse gas production were immediately halted, our mean temperature will continue rising until our climate finds itself at a new equilibrium point. Presently, median expectations are for a 1.5-2.0°C (2.7-3.6°F) rise by 2050. The company also benefits from the AIM act. The EPA is forcing industries to phase out the use of certain HFCs.
The company has achieved significant growth over the last decade. In 2013 they had an annual revenue of $58.6M. By 2022 that had grown to $325.2M. This represents a total increase of 454.95% at an average annual rate of 50.55%.
They have paid off the last of their long-term debt. The most recent quarter, Hudson had -$4.4M in net interest expense, total debt was at $10.2M, and long-term debt fell to $0.
Financial Metrics
Liquidity
Liquidity refers to the ease with which an asset can be quickly bought or sold in the market without causing a significant change in its price. In simpler terms, it's a measure of how easily an asset can be converted into cash without impacting its value. High liquidity suggests that an asset can be quickly turned into cash, while low liquidity indicates the opposite.
Key Ratios to Measure Liquidity:
1. Current Ratio = Current Assets / Current Liabilities
The current ratio measures the ability of a company to cover its short-term liabilities with its short-term assets. A ratio greater than 1 indicates that a company has more assets than liabilities, which is generally considered a sign of good liquidity. Considering Hudson Technologies’ current ratio, the company went from 161% at the end of 2019 to 336% at the end of 2022. This means that the potential to meet its immediate financial obligations has been growing since 2019. The current ratio is now 3.67.
2. Quick Ratio = (Current Assets - Inventory) / Current Liabilities
The quick ratio is a more stringent measure of liquidity as it excludes inventory, which may not be as easily convertible to cash. A ratio of 1 or higher is often considered satisfactory. About the quick ratio, which is now 0.92, it is also has been growing from the end of 2019 where it was 32% to the end of 2022 where it is 59%. That means without inventory the company could have difficulties to meeting the short-term obligations.
3. Cash Ratio = Cash and Cash Equivalents / Current Liabilities
The cash ratio is the most conservative liquidity ratio, focusing only on the most liquid assets. A higher cash ratio suggests a better ability to cover short-term liabilities with cash. The cash ratio grew from 5.6% at the end of 2019 to 10%, almost double, and it is 0.10. The enterprise could have serious issues to cover the short-term obligations with cash.
Profitability
Profitability is a key metric that measures a company's ability to generate profit relative to its expenses and other relevant costs. It is a crucial aspect of financial analysis and provides insights into a company's overall financial health and performance.
The metrics provide different perspectives on a company's profitability: ROE focuses on equity, ROIC considers overall invested capital, Net Profit Margin analyzes the proportion of profit relative to revenue, and Net Revenue is a measure of total revenue after adjustments. Analyzing these metrics together can give a comprehensive view of a company's financial performance and efficiency.
- ROE = Net Income / Shareholders' Equity
It is a ratio that measures the return on shareholders' equity. ROE indicates how effectively a company is using shareholders' equity to generate profit.
- ROIC = Net Operating Profit After Taxes (NOPAT) / Invested Capital.
It measures the efficiency with which a company utilizes its invested capital to generate profit. It considers both equity and debt.
- Net Profit Margin = Net Income / Net Revenue
It is a percentage that represents the profitability of a company by expressing its net income as a percentage of its revenue. Net Profit Margin shows how much profit a company retains from its revenue after all expenses.
- Net Revenue, also known as Net Sales or Revenue, represents the total revenue generated by a company after deducting returns, allowances, and discounts.
Hudson Technologies doesn't pay any dividend currently which essentially means that it has been reinvesting all its profits into the business. This definitely contributes to high earnings growth. The company is reinvesting a huge chunk of its profits at a high rate of return and this has caused the company to see substantial growth in its earnings. As we can see the company has a great ROE’s value of 27.43%.
Hudson Technologies’ annualized return on invested capital for the quarter that ended in Sep. 2023 was 28.2%. Hudson Technologies generates higher returns on investment than it costs the company to raise the capital needed for that investment. It is earning excess returns. A firm that expects to continue generating positive excess returns on new investments in the future will see its value increase as growth increases.
Hudson Technologies net profit margin as of September 30, 2023, is 18.31% which is considered a good net profit margin.
For the quarter ended December 31, 2022, Hudson reported revenues of $47.4 million, an increase of 26% compared to revenues of $37.8 million in the comparable 2021 period. For the year ended December 31, 2022, Hudson reported revenues of $325.2 million, an increase of 69% compared to revenues of $192.7 million for full year 2021. The revenue growth was driven by increased selling prices for certain refrigerants during the period as well as increased sales volume in the quarter as compared to 2021.
Financial Leverage
Debt Ratio = Total Debt / Total Assets
This ratio indicates the proportion of a company's assets that are financed by debt. A higher debt ratio suggests a higher level of financial risk, as it means a larger portion of the company's assets is funded by debt. A debt ratio of 3.49% suggests that only 3.49% of HDSN’ total assets are funded through debt. This is generally considered a good sign, indicating that the company relies less on debt to support its assets, which can lead to lower financial risk.
Debt Equity Ratio = Total Debt / Shareholders' Equity
This ratio measures the relative contribution of creditors and shareholders to the company's financing. A higher debt equity ratio suggests higher financial leverage and, therefore, higher risk, as it implies a larger portion of the company's funding comes from debt rather than equity. A debt equity ratio of 2.23% means that 2.23% of HDSN's financing comes from debt, while the remaining 97.77% comes from equity. This indicates that HDSN has a high equity stake in its capital structure, which is a good sign as it signifies lower financial leverage and reduced risk.
Total Debt to Capitalization = Total Debt / (Total Debt + Shareholders' Equity)
This ratio shows the proportion of a company's capitalization that is represented by debt. It gives an idea of the extent to which a company relies on debt to finance its operations. A higher ratio indicates a higher dependence on debt for funding. A total debt to capitalization ratio of 4.3% indicates that 4.3% of HDSN's total capitalization is in the form of debt. A lower ratio is typically considered a good sign, as it implies a lower reliance on debt for capital.
Interest Coverage Ratio = Earnings Before Interest and Taxes (EBIT) / Interest Expense
This ratio assesses a company's ability to meet its interest obligations on outstanding debt. A higher interest coverage ratio indicates a lower risk of default, as the company is generating sufficient earnings to cover its interest expenses. An interest coverage ratio of 794% indicates that HDSN's earnings are 794% more than sufficient to cover its interest expenses. This is a strong indicator, suggesting that the company has a comfortable buffer to meet its interest obligations.
Cash Flow to Debt Ratio = Operating Cash Flow / Total Debt
This ratio measures a company's ability to generate enough cash flow to cover its total debt obligations. A higher ratio suggests a better ability to service debt from its operating cash flow, indicating financial strength. A ratio of 494% implies that HDSN generates cash flow more than twice the amount needed to cover its debt obligations. This is a very positive sign, indicating robust financial health and the capacity to easily manage debt.
Stock Valuation
Multiple Analysis
Multiple analysis refers to the use of financial ratios or multiples to assess and compare the valuation of a company. These ratios express the relationship between one financial metric and another and are useful for comparing companies within the same industry or sector. Some common multiples include the price-to-earnings ratio (P/E), price-to-sales ratio (P/S), and enterprise value-to-EBITDA ratio. We decided to value multiples such as EV/EBITDA and P/E ratio, to gain insights into how the market values Hudson Technologies compared to its competitors.
Hudson Technologies' EV/EBITDA ratio stands at approximately 6.41, indicating that investors value the company at about 6.41 times its EBITDA. A lower EV/EBITDA ratio may imply that investors are currently paying less for each dollar of EBITDA generated by Hudson Technologies. This could be attributed to various factors, including expectations about future growth, risk considerations, or other market dynamics. The P/E ratio for Hudson Technologies is approximately 10.2, implying that investors are willing to pay roughly 10.2 times the current share price relative to its per-share earnings.
Discounted Cash Flow Analysis
Discounted Cash Flow (DCF) analysis is a method used to value an investment based on its expected future cash flows. The basic premise of DCF analysis is that the value of money decreases over time due to factors such as inflation and the opportunity cost of capital. As a matter of facts this model utilizes future cash flows, discounted to their present value, to determine the present value of a company's assets. It is also based on the concept that the intrinsic value of an investment is the present value of its expected future cash flows. This model is driven by Unlevered Free Cash Flow as this represents cash that is available for debt and equity holders and is calculated as EBIT minus taxes, plus D&A, minus CaPEx and change in Net Working Capital. To calculate the present value of a company using the DCF model, we have forecasted future cash flows for HDSN, considering factors such as revenue growth, operating expenses, capital expenditures, and taxes. These forecasts were then discounted back to their present value using the company's weighted average cost of capital (WACC). This is a financial metric that measures the average cost of capital for a company. It is a calculation that takes into account the cost of both equity and debt capital, weighted by their respective proportions in the company's capital structure.
For our analysis of HDSN, we found the WACC to be around 9,51%. It is however important to notice that this measure relies on several assumptions and specific circumstances; particularly, by changing beta and the market risk premium assumptions, the WACC value can change considerably. A WACC of 9,51% suggests that, on average, the company needs to generate a return of 9,51% on its investments to cover the cost of capital and meet the expectations of its investors. It serves as a benchmark for evaluating the attractiveness of investment projects or assessing the company's overall financial performance. It is neither exceptionally high, indicating excessive risk, nor exceptionally low, indicating a very safe investment.
Future Projections
For the FCF estimations we assumed a constant growth of revenue around 300M for 2023 with an increasing growth in the next few years due to the negative trend we saw with climate change. We kept strong EBIT margins initially soaring around 42% until 2022 and then fluctuated around 35% and a constant tax rate around 18%. We assumed D&A to grow in years and CapEX to remain stable.
The sensitivity analysis is a valuable technique utilized to evaluate how changes in critical assumptions or variables can impact the valuation of a company, project, or investment. It helps in comprehending the sensitivity of the valuation to various factors and enables decision-makers to assess the potential risks and uncertainties associated with the valuation process. In this context, two key metrics that have been chosen for analysis are the Weighted Average Cost of Capital (WACC) and Terminal Growth Rate (TGR) due to their significant influence on the valuation outcomes. By performing a sensitivity analysis on the WACC, one can assess how variations in the cost of capital, influenced by factors such as changes in interest rates or market conditions, affect the overall valuation. Conducting a sensitivity analysis on the TGR helps in examining how changes in growth assumptions impact the valuation. Subsequently, we calculated the terminal value using two distinct methods: perpetuity growth and EBITDA exit multiple.
In the first method, we applied a growth rate of 3.5%. This approach yielded a stock price of $15.82. In the second method, we used an EBITDA exit multiple of 10x, in line with the value of the competitors. Using this approach, we arrived at a stock price of $32.
Piotroski Score
The Piotroski Score, developed by Joseph Piotroski, is a financial scoring system that evaluates the financial strength of a company based on certain accounting and financial metrics. The score is designed to help identify companies with strong fundamentals and avoid those with weaker financial positions. Piotroski originally introduced this scoring system in a research paper titled "Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers." The Piotroski Score consists of nine criteria, each assigned a score of 0 or 1, and the total score ranges from 0 to 9. A higher score indicates stronger financial health.
The Piotroski score is broken down into the following categories:
Profitability (1 point if the company has a):
Positive net income
Positive return on assets (ROA) in the current year
Positive operating cash flow in the current year
Cash flow from operations being greater than net Income (quality of earnings)
Leverage, liquidity, and source of funds (1 point if the company has):
Lower amount of long-term debt in the current period, compared to the previous year (decreased leverage)
Higher current ratio this year compared to the previous year (more liquidity)
No new shares issued in the last year (lack of dilution)
Operating efficiency (1 point if the company has):
A higher gross margin compared to the previous year (1 point)
A higher asset turnover ratio compared to the previous year (1 point)
After calculating the scores for each criterion, they are summed to obtain the overall Piotroski Score. A higher score (closer to 9) suggests better financial health, while a lower score may indicate potential financial weaknesses.
Looking at Hudson Technologies’ financial factors (as September 2023), analyzing company’s profitability using the Piotroski Score framework:
Positive net income of 13.580.000
Positive return on assets (ROA) of 18.40%
Positive operating cash flow of 54.300.000
Cash flow from operations being greater than net Income (63.000.000>13.580.000)
Analyzing company’s leverage, liquidity, and source of funds using the Piotroski Score framework:
Lower amount of long-term debt in the current period, compared to the previous year [0<50.000.000 (30/09/2023)]
Higher current ratio this year compared to the previous year [3.47>3.26 (30/09/2023)]
No new shares issued in the last year
Analyzing company’s operating efficiency using the Piotroski Score framework:
A lower gross margin compared to the previous year [38.97%<51.90% (30/09/2023)]
A lower asset turnover ratio compared to the previous year [1.02<1.36 (30/09/2023)]
In conclusion, based on the analysis of the Piotroski Score components for Hudson technologies, the company receives a score of 7 out of 9 on the Piotroski score scale. This result suggests that Hudson Technologies does not face financial challenges and weaknesses in its current financial health.
Risks
HDSN aggressively paid down its debt, culminating in the full repayment of its term loan ahead of the March 2027 maturity date. Today, HDSN's debt-to-equity ratio is almost zero thanks to the remaining minor liabilities on the balance sheet, which significantly reduces the company's credit risk.
As it always comes with investing in stocks, HDSN has plenty of different risk factors in the competitive claims management industry that should be taken into account. First off, the company faces the challenges of economic downturns impacting demand, regulatory changes affecting operations, and potential strain from catastrophic events leading to a surge in claims. Technology risks, integration challenges from historical acquisitions, dependence on a few major clients, and pricing pressure from cost-conscious insurers are additional concerns. The labor shortage in the industry and the potential for reputational damage further contribute to the risk profile. Specific to HDSN, its relatively small size, vulnerability to new entrants, and reliance on a limited set of products and services pose additional risks that investors should carefully consider before making investment decisions.
But despite the relatively high risk, the reward side of the equation could be much more attractive. HDSN's multiple has risen quite a bit over the past year, but still, the company has become even more attractive compared to other more leveraged and less marginal players in the industry.
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