ChampionX Corporation

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

ChampionX is a global leader in chemistry solutions, artificial lift systems, and highly engineered equipment that help companies drill for oil and gas safely and efficiently.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: ChampionX operates in a challenging but critical niche within the energy sector. The company primarily provides solutions for the oil and gas industry, a market that is notoriously cyclical and vulnerable to price swings and macroeconomic factors. The company segments its business into four areas: Production Chemicals, Production & Automation Technologies, Drilling Technologies, and Reservoir Chemical Technologies. The company recently announced a merger with SLB and is operating as a wholly owned subsidiary.

Revenue Distribution and Trends CHX’s revenue is diversified across its four segments:

Production Chemical Technologies: This segment provides solutions for oil and gas production, including chemicals to enhance production, improve pipeline flow, and reduce scaling and corrosion, with operations spread across the Middle East, Latin America, and North America.
Production & Automation Technologies: This segment includes artificial lift systems, primarily used to produce oil from low-pressure wells. The company also offers automation equipment and engineering services. Operations are in North America and increasingly in the Middle East.
Drilling Technologies: This area focuses on engineered products for the wellbore, including drill bits and drill string components.
Reservoir Chemical Technologies: These offerings include technologies for improving reservoir stimulation and water treatment.
Most of the revenue comes from international sales and the majority from Production Chemical technologies. These segments also have relatively stable demand as compared to some cyclical segments like Drilling Techologies.

The company is continuing to enhance the technological and digital aspects of its operations. The company’s exposure to international markets and the impact of fluctuations in foreign currency exchange rates also must be considered. There’s a transition towards the more recurring revenue stream from automation and digital assets.

Competitive Landscape: The oil and gas industry is inherently competitive, with a number of large, established players in each segment, as well as smaller niche players. CHX faces competition from giants like Halliburton, Schlumberger, and Baker Hughes, as well as smaller specialized firms. The strength of its moat in specific niches is a crucial point of differentiation. While competitors try to develop competing technologies or build a similar geographical footprint, the high investment requirements can make it very difficult for others to take a significant market share. The large, established players can also try to push down prices if their products compete directly with CHX, though CHX’s focus on specialized areas reduces this risk.

What Makes ChampionX Different: While CHX’s markets are cyclical, there are areas where the company can leverage its specialized operations to get a competitive edge. The company emphasizes innovative and differentiated products that cater to specific needs within its chosen areas of focus.

Technological Leadership: The company emphasizes innovative and differentiated products that cater to specific needs within its chosen segments.
Operational Efficiency: CHX aims to control costs and produce products efficiently while providing high-quality services.
Customer relationships and supply chain: The company is very close to customers and this tight integration can result in repeat business. Moreover, the company also has global scale in its supply chains, helping to keep costs in check.

Legitimate Risks to the Moat and Business Resilience Here are some of the risks that could negatively affect CHX’s business:

Cyclicality of Oil and Gas Industry: The most pressing risk is the extreme cyclicality of the oil and gas sector. Downturns in oil prices can lead to significant reductions in capital spending by oil and gas companies, resulting in lower demand for CHX’s products and services, which is highlighted by several analysts.
Competition: While CHX has carve out some areas for high returns and its moat does offer some protection, it still has to compete with other players in the industry. If better technology is adopted by competitors, this could impact CHX’s returns.
Merger-Related Risks: The recent merger with SLB could present integration challenges, potential loss of key employees, or unforeseen costs that can affect profitability. The synergy from this could also be slow to realize.
Geopolitical Risks: Given that CHX operates in regions where there are greater geopolitical risks like the Middle East and Latin America, it’s exposure to the political conditions is higher than other parts of the market.
Regulation: There is a constantly changing regulatory environment around the world for energy and chemical companies. This may impact CHX directly through new requirements for its operations or indirectly through its customers.
Material Costs: Increasing material costs can be a problem for CHX’s earnings. Given that the company relies on large amount of raw materials and metals to produce its products, large increases in prices can seriously affect profitability.
Technological Disruptions: While CHX has a moat in its business, it is not immune to the effects of technological innovations and market disruptions that may result in other ways of getting energy resources, lowering demand for CHX’s products.

The business’s resilience lies in its global customer base, its diversified product offerings, and its expertise in specialized applications. Although the company does operate in highly volatile markets, the integration with SLB is likely to lower this volatility by having a wider global reach.

Financials in Depth

Revenue Growth: In the 9 months ended September 2024, revenue increased 6.3% year over year to $1.68 billion compared to the previous year. On a sequential basis, there is growth for Production Chemical technologies, while other segments have declines or stagnation due to pricing impacts.
Operating Margins: Gross margins were 29.5%, a slight decrease from 30% in the last year. This decrease is mainly due to the shift in product mix and slightly higher costs. However, selling, general, and administrative expenses have decreased year over year.
Net Income: Net income was $172.5 million, or $0.68 per share, down from $217.6 million from the same period in the previous year. This shows that the profitability has been affected.
Capital Expenditures Capital expenditures for the 9 months were $143.7 million. In that same timeframe the company purchased back stock for about 1.6 billion dollars, which has been funded using both operational cash and debt, indicating the company might be looking to reduce the overall equity stake and boost profits per share, which is why this number needs to be watched carefully.
Balance Sheet: CHX’s balance sheet has some good and some not so good aspects. On the one hand, its current assets are slightly greater than its current liabilities which indicates the ability to handle immediate commitments. The cash and short-term investments are adequate as well, implying that CHX has good liquidity. However, the debt level of the company is very large and almost two times its equity. The large debt implies risks for the company given the cyclical nature of its earnings and any issues with the merger can potentially lead to financial distress. Moreover, the company has a goodwill of $698 million, that is significantly higher than its retained earnings, which can lead to concerns about accounting quality. Intangible assets are also large and may need to be written down in the future if the company overpaid for the acquisitions.
Cash Flow: The company had a negative cash flow of $173.7 million in the past 9 months, which should be due to heavy acquisition spending and capital investment. However, a major portion of the acquisitions were done using debt. This implies that cash flow may remain positive in future quarters, but is important to keep a close watch on it.
Outlook and Forward-Looking Statements: In the latest 10Q, management mentions that it remains confident in the business despite many challenging economic conditions. The management also reiterates that the merger with SLB will position the company for future growth. There is also an expectation of positive revenue growth in the near future.

Moat Rating Justification: 3 / 5 CHX’s moat is not wide, but can be described as “narrow”. The company has certain durable competitive advantages in specialized niches and a wide distribution network. However, it operates in a very challenging and cyclical industry that is heavily dependent on market conditions.

Strengths: CHX benefits from a global reach, a loyal customer base, and its scale and specialization which allow for a moat but it is limited to specific businesses.
Weaknesses: The company operates in a market that is prone to technological disruptions, high competition and where customers are primarily focused on price, limiting its pricing power.

The merger with SLB provides additional opportunities for growth and innovation, but they bring along new risks as well, so this must also be considered for the moat.

Understandability: 3 / 5 CHX’s business model is understandable on the surface, given its operations in the energy and chemical markets, it becomes increasingly complex when we consider its financial situation, and the effects of merger. The dependence on cyclical industries and intangible assets also make it relatively difficult to predict the future. As such, this business falls on medium end of understandability. The complexity increases when one tries to understand the impact of recent mergers and economic factors on the company.

Balance Sheet Health: 4 / 5 The company has enough liquid assets to cover short term requirements. However, a substantial amount of debt that must be taken into account. The company’s debt will need to be closely watched over time. A large amount of goodwill should also be monitored closely, because there is an inherent risk of writedowns in the future. The increase in short-term debt from past three months also raises some concerns. Overall the balance sheet is good enough for the company with few risks associated with it.