Rounding out a tough year for Hudson, Q4’18 showed further pricing pressure for the company. Based on mgmt commentary, pricing was ~$10.5/lbs for its benchmark product, down from ~$14.5/lbs in the prior year quarter. However, sales volumes actually increased 38% in the quarter, in what is typically a seasonally slow period.
This is encouraging to me as it seems the original thesis is showing signs of playing out. Recall, I attributed much of the pressure in the business to destocking ahead of the phase-out of R-22. With prices declining, particularly as foreign producers try to capture the last bit of market share, buyers are incentivized to wait to buy inventory. Why buy now when I can wait a couple weeks and get a better price?
The Q4 volume print tells me a couple things. First, volumes likely hit their low point and now customers need to re-stock in 2019. With r-22 refrigerants set to phase-down virgin production from 9MM lbs to just 4.5MM and then zero in 2020, I think we could see a restock plus pricing moving up dramatically from lower supply. As the company noted on its latest call, it thinks there is about 40MM lbs of demand, which bodes well for the company and pricing.
As the company stated on the call:
There’s nothing that tells us that the price of 22 shouldn’t be back in the $20s and maybe beyond that. And there are times that we’ve said, maybe it goes to $30 a pound as was the case with the CFC phaseout, and some of the CFCs still are trading above that level. So we still believe that’s going to happen. What is difficult to say is what year is that going to happen and when is it going to rebound. We certainly still believe that 2019 is the last year of any material stockpile in the supply chain. So we do think there is the possibility of higher prices later this year in R-22, and we certainly do think there will be higher prices of R-22 next year, 2020. So we do expect to start to pay again higher economics, which hopefully then induces folks to return more gas
Using the company’s disclosure of realized prices during the quarter, I can back into a proxy for pounds of product sold. This gets me to ~15.5MM lbs sold. If I then assume we will see re-stocking to the tune of ~30%, that moves the volume sold to 20MM lbs. I don’t think this is unreasonable for a few reasons.
First, the company witnessed destocking of this amount already in 2018. This would just get us back to the base level. This then, therefore, would ignore that virgin production is going away, which should be incremental volume opportunity for the company.
Assuming pricing gets back to $20/lbs and gross margins improve, I think the company could reasonably get to $50MM of EBITDA. The company’s GMs were ~30% of sales in 2016 and in the future, they will be reclaiming spent product and re-selling it. That theoretically should be higher margin. The company stated that reclaim may be bigger in 2020 and 2021, so I’m baking in some additional conservatism.
For valuation context, I think the company still has significant upside from here, as shown below. Note, I support this with a normalized FCF figure as well and my price target is >7% FCF yield, which I think is attractive.