Luxfer Holdings: Not In A Rush To Own It For Now (NYSE:LXFR)

Introduction

Luxfer Holdings (NYSE:LXFR) recently reported its Q2 earnings, which initially were met positively but eventually turned around and since then, the company’s share price plummeted around 20%. The last time I covered the company was back in November ’23, when I said that the price decline was justified mainly because of the weakness in the Elektron segment and overall macroeconomic conditions, therefore, I avoided buying. The market had other ideas, and pushed the shares up 27.5% since then, compared to a 15% increase in the S&P500 (SPY). I am maintaining a hold rating on the company, and I am not in a rush to start a position for now. I would need to see how the two segments perform over the remained of the year.

Recent Quarter Results

Let’s take it from the top. The company’s net sales came in at $99.7m, down around -10% y/y, and in line with consensus estimates. Sequentially, the company saw an 11.5% growth. Due to costs related to the disposition of the Graphics Arts segment, the company went GAAP negative this quarter. The loss was slightly offset by the $5.1m legal cost recovery. In GAAP terms, the company’s EPS came in at $-0.01 compared to $0.18 the prior year. In adjusted terms, EPS came in at $0.39, a beat of $0.15 due to the unexpected recovery of legal costs this quarter.

Furthermore, the company raised its FY24 outlook to include the recovered legal costs, as per below.

So, overall, the results were decent. There was decent growth coming from its main revenue generator, the Gas Cylinder segment, which came in at 2.7% y/y, 9.7% q/q. In contrast, the Elektron business segment saw a decent growth q/q of 11.4%, while down a whopping -20.8% y/y due to the softness in key end-markets. The same is true for efficiency. Margins of the Gas Cylinder saw an improvement y/y, while the Elektron continued to lag.

The market didn’t seem to like the report, even though when companies raise forward guidance, we can see a massive pump in share price. Not this time. Ever since the announcement, the company’s share price tumbled over -18% as of writing this update, which could be mostly due to the overall market fears of a recession in the past couple of days, but also some of it is due to the market perceiving not a great quarter, which I don’t agree. The massive miss on GAAP EPS could be one of the reasons it tanked following the report, -$0.02 vs $0.22 consensus. However, the next quarter will show a marked improvement as the one-time costs associated with the disposal of the segment will not be affecting the bottom line any longer, or at least that’s what everyone thinks for now.

In terms of the company’s financial position, the company has around $4.3m in cash and $74m in long-term debt. That’s an increase of $10m y/y in debt, which is not great but certainly not too risky. However, if the company’s operations don’t improve, it would be hard to cover the annual interest expense on debt. The average interest rate it is paying on that debt is around 7%, which is rather high. I would like to see the company bringing it down over the next year or so.

Comments on the Outlook

I would like to see the company prioritizing the CNG part of the business. Compressed Natural gas, CNG, is used in alternative fuel vehicles, which may not get as much range as the two most popular ones like gasoline and battery, but there are still a lot of opportunities here. The company did mention that it expects to see growth in 2025 from this segment, however, didn’t give us any concrete numbers. Cummins (CMI) is developing a new engine that will utilize CNG, and LXFR is excited about that, however, I’m not sure if it is going to be enough to push the growth rate to new highs. The company needs more catalysts. For example, India is heavily involved in CNG. It has decent infrastructure to support alternative vehicle usage. For example, Tata Motors and Maruti Suzuki are leading the charge there. The company currently operates in 4 countries, the UK, the US, Canada, and China. Some time ago, the company had a joint venture with Uttam Air Products of India but sold the 51% steak it held to the partner back in 2020, so I think it’s time to get back into that region as there is where the demand for CNG lies.

The Elektron segment continues to struggle, however, as shown above, we are seeing some recovery happening sequentially. It is a good sign of a turnaround and with the tough comps almost behind us, I am expecting the segment to show decent growth next year. I mentioned in my previous article that the segment was the darling up until FY22, after that there were a lot of supply chain issues, and the company had to find other sources of magnesium because of the disruptions originating from the US. In the latest quarter, the company didn’t mention any specific efforts to improve the segment, therefore, I would like to get more information on how the management is going to reduce costs going forward. Hopefully in the next report.

Speaking of efficiency, the sale of the Graphic Arts segment I view as a very positive. I would like the management to focus on what is working for them. Graphic Arts clearly wasn’t working. Now that that is off the books, the management can put all their efforts into improving the efficiency of the Elektron segment and support the growth of the Gas Cylinder segment. Streamlining business should improve efficiency and profitability overall.

In short, the company can do a lot more to improve its growth. There is plenty of room to expand its CNG segment by re-entering the Indian market. The Elektron segment may turn itself around without much input from the management, however, with a little more aggressive push, it would recover much more quickly.

Valuation

Let’s look at some updated assumptions.

For revenue growth, it looks like the company is on a -10% decline for FY24, which is due to it losing the graphic arts segment, therefore in the following year, analysts and I expect to see some sort of growth return. I went with 7% for FY25, which will taper off to 2% by FY33, giving me a 3% CAGR over the decade. This seems to be achievable if the company captures market share and opportunities going forward. The last 3-year CAGR stood at over 4%, so my assumptions are more or less in line.

In terms of margins, I am sure the company can improve these going forward, but I am not confident in making these improvements too high, therefore I went with a 200bps improvement in gross margins and 400bps in EBIT margins over the next decade. The company’s adjusted EBITDA margins saw decent improvements y/y, so I am comfortable with only slight improvements going forward.

For the DCF analysis, I went with the company’s WACC of around 8% as my discount rate and a 2.5% terminal growth rate. In case all these numbers are still too optimistic, I decided to add a discount of 30% to the final intrinsic value, just to give myself more room for error in these estimates.

With that said, Luxfer’s intrinsic value is somewhere around $9.66 a share, which means it is still trading above its fair value.

Closing Comments

So, I am not in a hurry to add the company to my portfolio just yet. I would like to see a few more earning reports before taking the plunge. I would like to see how the two segments perform the rest of the year, and whether we will see a recovery in the Elektron segment that could help the company’s top-line growth. Furthermore, I would like to see how the company’s Gas Cylinder continues to perform. I would like to see decent growth going forward and would like to hear what initiatives and partnerships it is going to form going forward, especially in the CNG segment of the business, which I think has a lot of potential going forward. The company expects 2025 to be the year, but it would be great to see this happening sooner. I maintain a hold rating for LXFR and will continue to monitor the company’s progress and the overall market fluctuations, which have been showing a lot of jittering in the past week due to the fears of recession and rotation.