Description

We believe ChampionX (CHX) is a compelling long. The recent wave of enthusiasm around all things energy after a nearly a decade of hopelessness has drawn many generalist investors to revisit the well-known industry bellwethers (SLB, HAL, XOM, CVX), or the higher-beta independent E&Ps. ChampionX has been largely left behind, as it’s a lesser-know midcap with less leverage to oil prices. If you’re looking for energy exposure and you don’t want to chase a name that has already ripped or that might be exposed to a correction in oil prices, we believe CHX is a compelling “chicken energy play” where the stock is actually down over the LTM and the business quality is among the highest in the broader energy space.

You can think about CHX as either an oilfield services/equipment provider, or as an industrial company that is fully exposed to energy end-markets. The company in its current form is the product of the 2020 merger of Apergy (APY), the former energy business of Dover’s (DOV), with Nalco Champion, the former upstream energy business of Ecolab’s (ECL). While DOV and ECL both felt their equity stories were being weighed down by the perceived cyclicality of their energy business, the resulting CHX is in fact one of the least-cyclical names in oilfield services.

The key defining characteristic of CHX is that it is driven by oil production (80% of sales), not investment. As long as there is oil flowing out of the wells, there will be demand for CHX products and services. This results in a much more steady business than the very capex-heavy boom and bust pattern of other oilfield services such as pressure pumping, drilling services and such.

The company reports 4 segments. To dumb it down, production chemicals and artificial lift are the business lines that really move the needle.

The company has a balanced geographical exposure, with 60% of sales in North America and 40% in RoW.

The company has guided to 18% EBITDA margins exiting 2022. While this is below what SLB or HAL report (low 20%s), CHX’s manufacturing-oriented business model is less capital intensive (capex is 2.5-3% of sales, versus >5% for most oilfield service companies). This translates into 50-60% FCF/EBITDA conversion rates, well ahead of other oilfield services companies.

We see CHX growing top-line at mid-single digit rates in 2023 and beyond, which should translate into low-double digit sustained EPS growth. CHX should generate $400-450mm FCF in 2023, which puts the stock at a 8.5-9% FCF yield. We think this is solid value and the stock can compound at mid teens to 20% over the next few years as the company benefits from higher global oil production and the stock gets more recognition from generalist investors.

We quite like the company’s management – CEO “Soma” Somasundaram used to run the Apergy business at DOV and is operationally a safe pair of hands. He is also savvy managing expectations, and tends to underpromise and overdeliver. One point where the company ran into investor frustration recently is capital allocation: investors are currently nothing short of obsessed with energy companies returning as much of FCF as possible through dividends and buybacks. Some E&Ps are returning 10%+ of marketcap annually, which seems to have raised expectations for capital return across the industry. CHX got dinged on February 9^th during its 4Q21 earnings call when the company spoke against buybacks, arguing that share repurchases have historically not created value in the energy industry. While this is probably true (for most companies buybacks have been extremely procyclical), it was not the message that investors wanted to hear, and the stock sold off 7%. A couple of weeks later, the company did announce a $250mm repurchase authorization, but didn’t commit to executing on it nor to any particular timing. Net net, we don’t think there is risk of value-destructive M&A. Soma is not into empire building, but likely just a prudent manager that doesn’t want to buy back stock aggressively with oil prices at these levels.

Catalyst

• Executing on the buyback authorization
• Continued investor interest in energy names