Description

Luxfer Holdings PLC

Summary

Luxfer Holdings PLC (“Luxfer,” ticker LXFR) is a ~$500 million market cap global materials technology company dominant in several disparate niches: high performance gas cylinders, magnesium alloys, and magnesium and zirconium powders. We see Luxfer as a solid high-quality business with leading market share and differentiated technology across its various focus areas, often inventing and capturing new niche markets. It has demonstrated strong mid-high teens ROIC and long-term we believe it can organically grow revenue mid- to high-single digits and grow earnings low-mid teens. We believe the management team, which joined in 2017, is very capable. Finally, the stock trades at a depressed multiple on forward earnings despite numerous reasons to be excited for the growth in revenues and earnings over the next several years. 

Within its portfolio, Luxfer has an alternatives fuel business where it is a leading manufacturer of specialized cylinders for compressed natural gas (CNG) and hydrogen applications. These products represent 10-15% of total revenues today but sales are poised to expand dramatically in the coming years given increased investments by municipalities and corporations to reduce carbon emissions in response to climate change. We believe this business’s growth could attract investor eyes and lead to a re-rate of the valuation. In the coming years, we believe the company can expand earnings dramatically and that the stock can +2x from current levels with limited risk of permanent capital loss considering the underlying value of the assets, strong FCF generation, and under-levered balance sheet (~1x Net Debt/EBITDA).

Background

The Company has two divisions: Gas Cylinders and Elektron. The assets within the Gas Cylinders division have origins in the late 1800s as the Chicago based Luxfer Prism Company. The assets within the Elektron division have roots in Manchester England dating back to the 1930s as a part of British Magnesium Company Ltd.  Both divisions have a long history of acquisitions, which left the company with twenty manufacturing facilities spread across seven countries. The assets were combined as part of British Alcan’s non-core asset divestiture program in the late 1990s. In 2017 the Company brought in new management in 2017 led by Alok Maskara, who led various initiatives to improve the consistency of the results, re-focus the business on growth areas, and right size the bloated cost structure including narrowing the manufacturing footprint.

Gas Cylinders

The Gas Cylinders division represents ~50% of total revenues and generates ~10% EBITDA margins. The crown jewel of the division is its composite cylinder product line, which is used for firefighter life support oxygen tanks. These tanks are highly engineered and must be extremely lightweight while also able to withstand extremely high pressures and heat. In this area it is a leading supplier to all fire kit OEMs in the US and is protected by a rigid equipment certification and approval process. Growth is modest but the margin and return profile is very strong.

In addition to various specialized and general-purpose cylinders for industrial and medical applications, the Company also produces cylinders for CNG and hydrogen alternative fuel applications. During the 2013-2014 period of high oil prices, the alternative fuel cylinder business line was seen as a large growth opportunity, but, when the price of oil declined, demand for alternative fuel tanks dried up and the business went from generating $5-10 million of EBITDA to incurring losses. Today the alternative fuels business is generating perhaps ~$50 million of revenue or 10-15% of total company revenues, but is growing double digits. The vast majority is associated with CNG applications (perhaps ~85%) versus hydrogen which is a relatively much less mature technology. Luxfer is a leading player in the market together with competitors Hexagon Composites ASA (ticker: HEX NO) and Worthington Industries, Inc (ticker: WOR). 

Demand for alternative fuel cylinders could expand 4x over the next 5 years fueled by government and commercial initiatives to reduce their carbon footprints. Battery powered electric vehicles (BEVs) are superior to CNG and hydrogen for many applications, however, for others, such as those involving heavy equipment, BEVs are less practical considering the battery requirements, the vehicle weight, and charge times. As a result, municipal governments around the world are converting buses, trains, and trash trucks to various types of alternative fuel powertrains (eg https://www.businesswire.com/news/home/20210208005062/en/Clean-Energy-Signs-Multi-Year-Contract-with-LA-Metro-for-More-Than-47-Million-Gallons-of-Renewable-Natural-Gas). On the commercial side, large corporations such as Amazon have launched initiatives to aggressively convert trucks and warehouse equipment to similar technologies (eg https://www.reuters.com/article/us-amazon-engines-natural-gas-exclusive-idUSKBN2A52ML). Another dynamic that could drive increased use of natural gas engines (and corresponding cylinder tank demand) is the increased availability of renewable natural gas (RNG). Depending on the source of the RNG, end users may be able to make near-zero, zero, or even negative CO2 emissions claims.

The company is a supplier to leading customers of these technologies, and we believe that it should be well positioned to benefit from this growth trend. We expect CNG to be the main driver versus hydrogen given the maturity of the technology, however, it should be noted that hydrogen is great from a PR perspective because it allows the customer to make the claim that the fuel cell powered vehicle is “zero emission” even if the initial energy used to create that hydrogen came from a power grid supported with coal and natural gas.

The alternative fuel cylinders themselves must be manufactured using carbon fiber to withstand high pressures while minimizing weight and meeting safety and environmental requirements. The company has a strong reputation with installed capacity and deep-know which we believe offer competitive advantages over others as demand ramps.

Elektron

The Elektron division comprises the remaining ~50% of the total revenue base and generates high teens EBITDA margins. Within Elektron, the company sells specialized magnesium alloys for use in aerospace, automotive, energy, and other applications. In performance applications, magnesium is used as a substitute for aluminum since it is similarly strong with one-third the weight. Flammable and corrosive, magnesium presents engineering challenges and the company specializes in creating proprietary alloys for specialized applications such as in performance magnesium wheels for Porsche and lightweight gear boxes for helicopters.

Elektron also sells magnesium and zirconium powders. Key product lines include powders for military aircraft decoy flares and flameless heaters for meals ready-to-eat (MRE) kits used by the US military, the Federal Emergency Management Agency (FEMA”), and foreign governments. In these categories, Luxfer is the number one supplier with high market share.

Another notable product line within Elektron is Solumag, where the company manufactures magnesium alloy balls and plugs that are used in the fracking process. Frack balls are used in connection with frack plugs to create pressure in various stages of a frack well. There has been a trend toward longer, multi-stage lateral wells which use more stages per well. This a growth driver for Solumag because each stage requires more of these downhole tools.  The company has a highly differentiated product but demand is currently depressed. We estimate that Luxfer generated ~$10m of EBITDA from this product line in 2018, but virtually none in 2019 and 2020. We believe that a recovery in this business may take time given the challenging backdrop for new drilling activity but is a potential source of upside.

Cost Restructuring

When Maskara joined in 2017 he launched a cost rationalization initiative including reducing its global manufacturing footprint. In aggregate it has delivered $18 million of run-rate cost savings with another $6 million anticipated to be delivered by the end of 2021.

Valuation

The company generated ~$1.4 of EPS pre-COVID (ie 2019) and is expected to produce ~$1 of EPS in 2020. Without considering the growth potential from alternative fuels we believe it can recover back to pre-COVID levels, which together with announced cost savings could result in ~$1.70 of EPS by 2022.  The stock is attractive against that backdrop (15x P/E x $1.70 => ~$25/share or ~30% over the next year). Now consider the impact of alternative fuels. We believe it is conceivable that the business could grow from ~$50 million of revenues today to $150 million of revenues over the next few years which could drive earnings of ~$2.50 and a re-rated multiple given its exposure to a high growth category. $2.50 of EPS x 20 P/E =>$50/share.

Downside Protection

With limited debt (~1x Net Debt / EBITDA) and solid businesses we believe the stock is very protected from permanent capital loss at current levels. With the business poised to recover in 2021, we believe share repurchase is an obvious use of cash this year should the stock price languish. The company has attracted private equity and strategic interest in the past and we believe could ultimately be sold if the management fails to deliver.

Catalyst

Catalysts

>Recovery in end markets

>Growth from alternative fuels