MEG - Heritage-Crystal Clean: Cleaning Up Nicely

2023-04-26 09:00:02 ET

Summary

• Heritage-Crystal Clean, Inc has demonstrated really solid performance as of late.
• The company's top and bottom lines have risen nicely, pushing shares up relative to the broader market.
• This is great to see, and despite some risk ahead, the picture for Heritage-Crystal Clean, Inc looks bullish right now.

As society has developed, a greater emphasis has been placed on specialization. Where once companies might handle all of their affairs, or substantially all of them, they now tend to outsource certain activities. The companies they outsource to, in theory, should be efficient enough to save the service receiver time and capital that they, ideally, can allocate toward what they themselves are best at. One company that I could point to as an example on this front that offers customers a variety of waste management services such as full service parts cleaning, wastewater vacuum services, antifreeze collection, recycling, and product sales, and more, is Heritage-Crystal Clean, Inc ( HCCI ).

Recently, backed by strong fundamental performance, shares of the company have roared higher. Even in spite of this movement up, the stock does look to be attractively priced at this time. Those who are bearish about the company would argue that some portion of the company, largely centered around its oil operations, is benefiting from a temporary situation. I would say that is a fair characterization. But even recently, management stated that the strength seen in that category should continue relative to historic levels throughout this year. So with no clear end insight to the improved bottom line of the enterprise, and continued growth by both organic means and acquisitions, I do believe that Heritage-Crystal Clean, Inc still warrants a "buy" prospect at this time.

Great performance across the board

At the tail end of November of last year, I wrote an article that took a bullish stance on Heritage-Crystal Clean. In that article, I talked about the robust fundamental performance that management had achieved, thanks not only to favorable market conditions, but also to wise decisions made by management. From a share price perspective, the company was already significantly outperforming the broader market. But even with that upside factored in, shares looked to be trading on the cheap. All of this, combined, caused me to rate the company a "buy" to reflect my belief at the time that shares should outperform the broader market for the foreseeable future.

Since then, that is precisely what happened. While the S&P 500 (SP500) is up 1.4%, shares of Heritage-Crystal Clean have seen an upside of 10.2%. And since first writing about the company in June of last year in an article in which I rated the company a "buy," the stock is up 36.7% compared to the 6% seen by the broader market.

To best understand and appreciate the movement higher in the company's share price, it would be wise to dig into the fundamental performance that the company has experienced as of late. The only quarter for which new data is available that was not available when I last wrote about the enterprise is the fourth quarter of the 2022 fiscal year . During that time, revenue came in at $241.1 million. That's 42.2% higher than the $169.5 million the company reported one year earlier.

The greatest surge the company experienced came from its Environmental Services segment, with revenue spiking 60% year over year. This is the part of the company that includes parts cleaning, waste disposal, wastewater vacuum services, and more. The largest portion of this growth came from the company's acquisition of Patriot, a transaction that was responsible for 35.3% of the company's growth in the final quarter of last year. This is not to say that organic growth was insignificant. In fact, it was incredibly robust, coming in at 24.7% year over year. Management has not provided a great deal of information on this front. They only said that demand for their services led to an increase in volume during that quarter and for the year as a whole. Meanwhile, the Oil Business that the company has also fared well. An increase in oil collection volumes, combined with stronger pricing spreads on its re-refining activities, were instrumental in pushing revenue higher to the tune of 14.3% in the final quarter.

On the bottom line, the picture for Heritage-Crystal Clean, Inc continues to improve as well. Net income of $27.6 million dwarfed the $18.1 million reported one year earlier. Operating cash flow expanded from $27.9 million to $34.2 million. If we adjust for changes in working capital, the metric would have risen from $32.8 million to $38.9 million. And finally, EBITDA for the company jumped from $35.7 million to $42.1 million. You can see, in the chart above, results for the 2022 fiscal year compared to 2021. These figures are similar in terms of overall trend to what we saw in the final quarter of each year respectively. This shows that the results experienced during the final quarter of last year were not a one-time event.

At some point, market conditions will stabilize. Truth be told, I don't have any long-term concerns when it comes to the Environmental Services segment of the company. Management has made investments aimed at permanently elevating revenue and profits. On top of this, these kinds of services will always be needed. There is some uncertainty, however, when it comes to the Oil Business that the company has. After all, the results of that segment have to do not only with volumes dealt with, but also with pricing spreads. This involves the spread between the net back, which is the sales price, net of freight impacts, on the base oil sales, and the price paid or charged to its customers for the removal of their used oil. And in this environment, this particular portion of the business is extremely valuable.

Despite accounting for only 36.7% of the company's overall revenue, it was responsible for 49.5% of its profits during 2022. Management did say that, this year, they hope to continue to increase their used oil collection volumes. However, base oil pricing did fall materially since reaching their peak levels in the second-half of 2022. Despite this, management said that they anticipate pricing to remain strong relative to historic standards, spreads remaining particularly robust in the first half of this year. This implies promising results for the company and its shareholders moving forward. Though at some point, perhaps by the end of this year or early next year, margins could come under pressure.

If we use data from the 2022 fiscal year, shares of Heritage-Crystal Clean, Inc look incredibly cheap. The firm is trading at a price to earnings multiple of 10. The price to adjusted operating cash flow multiple is even lower at 6.7, while the EV to EBITDA multiple is 6.1. Even if we assume that financial performance reverts back to what it was in 2021, the results of which you can see in the chart above, the stock still looks attractively priced in my opinion.

As part of my analysis, I also decided to compare the company to five similar enterprises. These are companies that deal in the waste management and / or facilities services space. On a price to earnings basis and on an EV to EBITDA basis, Heritage-Crystal Clean ended up being cheaper than any of the companies that had positive results. And when it comes to the price to operating cash flow approach, three of the five firms were cheaper than our target.

Takeaway

Fundamentally speaking, Heritage-Crystal Clean, Inc is doing quite well for itself. Revenue and profits are rising nicely. I do acknowledge that some of the upside the company has experienced is short term in nature. But given how cheap Heritage-Crystal Clean, Inc stock is and the structural changes that management has made, I am optimistic in the long run. Although the easy money for the company has definitely been made by this point, I do still think that Heritage-Crystal Clean, Inc offers some additional upside from here. Because of that, I have decided to keep Heritage-Crystal Clean, Inc rated a "buy" for now.

For further details see: