Despite reporting much stronger-than-expected results for the final quarter of 2022, shares of Hudson Technologies (HDSN) had a tough day, falling 9%. Specifically, the company reported Q4 revenues of $47.4 million and earnings of 11 cents per share, which comfortably exceeded the $37.4 million and 7 cents analysts had been projecting thanks to higher-than-anticipated selling prices and sales volume for certain refrigerants. Yet given how much stronger the top line was versus expectations, I believe investors were disappointed that the beat on the bottom line wasn’t better. This reflects the fact that HDSN’s gross margin for the period of 32% was significantly lower than the more than 40% management hinted at during its Q3 earnings call back in November and even below its long-term target of 35%.
While this suggests that the gap between its inventory costs and sales prices has narrowed somewhat quicker than expected, I believe it’s important to bear in mind that Q4 is seasonally HDSN’s weakest quarter because it falls outside of its nine-month selling season from January through September. Accordingly, revenues and gross margins are usually much lower than those achieved in the selling season. Thus, even a slightly faster moderation in refrigerant pricing could have an outsized impact on margin performance for the period. I believe this is why the company remains confident that it can bounce off this low and still achieve the normalized baseline gross margin of at least 35% this year and beyond.
More importantly, even if you assume no top-line growth in 2023, as well as the much higher effective tax rate of 26% HDSN now expects going forward (compared to the low 11% it enjoyed in 2022 due to the realization of a more than $14 million tax benefit associated with the release of income tax valuation allowances), this implies earnings per share for the current year won’t be that far off the $1.21 analysts were looking for at this targeted gross margin run-rate. What’s more, as we approach the next stepdown in HFC production and consumption levels under the AIM Act to 60% of baseline levels scheduled for 2024 (from 90% currently), refrigerant prices and demand for HDSN’s much-higher-margin reclaimed refrigerants should also continue to rise as the more than 125 million stationary units that the company estimates are still using HFCs begin looking for alternatives. Along with my expectation for a more gradual decline in gross margin from last year’s record of 50% to its 35% target rather than an immediate drop down to the latter, I think there is potential for significant outperformance in the year ahead.
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And let’s not forget, with the AIM Act starting with just a small 10% reduction in HFC production to 90% in 2022 and not calling for any additional stepdown in 2023, the real driver of HDSN’s future performance will be this additional 30% phasedown in 2024, followed by further reductions of 30% in 2029, 10% in 2034 and 5% in 2036, for a total reduction in production levels of 85% over this span. As this continues to play out, I believe HDSN remains in excellent position to deliver on its previously stated ambition of delivering annualized revenue in excess of $400 million by 2025. At its target gross margin run-rate, I estimate that earnings could rebound to over $1.50 per share by then. But with today’s undeserved slide in the stock now having it trading at an incredibly cheap 7.2 times even its reduced earnings expectation of $1.19 per share for 2023, I think the move back to the materially higher levels more reflective of this strong expected performance will begin much sooner.
Julius Juenemann, CFA is the equity analyst and associate editor of the Forbes Special Situation Survey and Forbes Investor investment newsletters. Hudson Technologies (HDSN) is a current recommendation in the Forbes Investor. To access this and the other stocks being recommended through the Forbes Investor, click here to subscribe.