Hudson Technologies: This Could Be a Good Time To Take Profits (NASDAQ: HDSN)

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Introduction

In April, I posted a bullish article on Hudson Technologies, Inc. (NASDAQ: HDSN), and this is one of my best stock picks to date. The company booked record for financial results Q1 2022, and its market valuation has soared by more than 40% since my article came out, briefly surpassing the $ 9.70 share price I gave just over two months ago.

However, the Q1 margins look unsustainable, and I expect them to come down over the coming months as the cost of inventory starts to increase through the year. Also, I think that joining the Russell 2000 Index could drag the share price down and that this could be a good time to take profits. Let’s review.

Overview of the latest developments

In case you haven’t read my previous article, Hudson Technologies is a provider of sustainable refrigerant products and services in the HVACR industry, and it has developed reclamation technology that can recover all refrigerants. The company holds about 35% of the reclamation market in the USA, which is crucial for the country to phase out climate-damaging hydrofluorocarbons (HFCs) by 15% of their baseline levels by 2036.

The start of this year marks the start of the implementation of the AIM Act regulations, which means there is a 10% reduction in production and consumption allowances for HFCs for 2022 and 2023. The reductions decrease by 40% in the baseline. 2024 and this means that reclaimed HFCs should increase from about 6 million pounds in 2020 to around 40 million pounds by 2024.

Hudson Technologies is already reaping the benefits of its leading position in the refrigerants reclamation market. In Q1 2022, revenues soared by almost 150% to $ 84.3 million while operating income came in at $ 38.3 million. The gross profit margin, in turn, rose to 54.33% from 27.05% a year ago.

Hudson Technologies Q1 2022 income statement

Hudson Technologies

Revenues were higher as a result of strong prices of certain refrigerants due to increased demand and limited industry supply and this means that this performance is not sustainable over the long term. The margins are expected to remain under pressure as the cost of inventory increases through 2022 due to high inflation across the globe. Hudson Technologies itself said during its Q1 2022 earnings call that it expects marginal performance for full to moderate levels similar to 2021. Last year, the company’s gross margin was 37.18%, which means we could see levels below 30% by the end. of 2022. As a reminder, this is a seasonal business with a traditional 9-month selling season that starts at the beginning of the year.

Turning out the cash flow situation, cash flow from operating activities in Q1 2022 was just $ 5.1 million as there was a significant increase in receivables and inventories due to higher sales.

Hudson Technologies Q1 2022 balance sheet

Hudson Technologies

This also led to a small increase in debt. Speaking of which, Hudson Technologies refinanced its debt in Q1, which resulted in a one-time interest expense of $ 4.6 million. Its long-term debt now stands at $ 100 million, with $ 83 million of it maturing in 2027.

Overall, I think this is a great quarter for Hudson Technologies that puts it one step closer to achieving its long-term annualized revenue and operating income of $ 350 million and $ 72 million, respectively. However, the next few quarters should be weaker from a financial point of view, and I think this could put pressure on the share price. Also, the strong Q1 2022 financial results and the influx of investors have helped Hudson Technologies become a part of the Russell 2000 Index effective June 27, which I think could lead to a decline in the share price. You see, indexers will need to buy about 4 million shares of the company, and many retail investors are expecting this event to provide a boost for the share price.

However, many indexers pre-position themselves by buying up Russell additions and short selling the deletions in the front of the reconstruction date, which means that the effect of joining the index is minimal. This could disappoint some retail investors in Hudson Technologies and thus hurt market sentiment.

Investor takeaway

The financial results of Hudson Technologies were unusually strong in Q1 2022, and I think this has provided a strong boost for the share price. However, the company itself admits that these margins are not sustainable over the long term and that its gross margin is likely to fall to the 2021 levels. Also, the stock is joining the Russell 2000 Index, and I think this has created overly optimistic expectations among some investors that the share price will increase, as indexers have to add about 4 million shares. I think this could be a good time for investors to take profits, as the share price could come under pressure over the next few months due to these two factors.

That being said, the implementation of the AIM Act will limit virgin HFC refrigerant production, and this should benefit reclamation companies like Hudson Technologies over the coming years. I think the company has a good chance of achieving its ambitions of reaching revenues of $ 350 million and operating income of $ 72 million by 2024.

In my view, there is a compelling investment opportunity here, but the share price is increasing too fast and there are no catalysts in the near future.

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