HCCI - Heritage-Crystal Clean Inc: Limited Upside As Buyout Deal Progresses

2023-09-04 10:34:37 ET

Summary

• Heritage-Crystal Clean, Inc is being sold to J.F. Lehman for $1.2 billion, causing a drop in share price.
• HCCI operates in industrial and environmental services, with a large customer base and potential for growth.
• The acquisition deal values HCCI at $45.50 per share, but there is limited upside potential for investors.

Investment Rundown

There was some significant news earlier this year that Heritage-Crystal Clean, Inc ( HCCI ) is being sold to J.F. Lehman for a deal valued at $1.2 billion in total. The share price for HCCI did drop though in the last few weeks as the market was expecting there to be a bidding war for the company, but with the lack of that, the arbitrage potential that investors are getting here did increase.

I like the business of HCCI even if the deal was to fall through for any reason and will be rating it a hold. The upside is limited from where the buyout per share is happening, which is $45.5. I don’t think it makes sense to buy heavily into the company right now, but perhaps rather just hold shares and wait for the deal to go through and capitalize on the slight gain from it. So to conclude, I am issuing a hold for HCCI right now.

Company Segments

HCCI operates as a prominent player in the realm of industrial and environmental services, offering a comprehensive suite of solutions that cater to a diverse range of needs. The company is a recognized leader in various sectors, including parts cleaning, used oil re-refining, and the management of hazardous and non-hazardous waste.

At the core of HCCI's operations lies its commitment to providing effective and sustainable solutions for its clients. The company's expertise spans multiple areas, allowing it to address challenges related to parts cleaning, waste management, and the responsible handling of used oil. By focusing on these critical aspects, HCCI contributes significantly to maintaining operational efficiency and environmental responsibility across various industries.

The company continues to be in a larger and more attractive market where there are several growth drives for it. Some important notes and characteristics to it are that there are around 810,000 establishments in the US right now that are engaging in the manufacturing of vehicle maintenance. That is a large customer base to severe and allows HCCI to continue doing business for a long time, in my opinion. The waste products that these establishments are generating are something that HCCI can take advantage of and start generating stronger top and bottom-line growth from.

Looking at the dividend of the segments in HCCI, there is around 49% of revenues coming from environmental services which I think is going to slightly increase as the market and demand for companies being more environmentally friendly is only going to increase with the years.

Company Buyout

In a significant development that unfolded in July of this year, Heritage-Crystal Clean made headlines with the announcement of its impending acquisition by J.F. Lehman & Company. This strategic move marked a pivotal step in the company's journey and garnered attention for its transformative impact on the industry landscape.

The acquisition deal, valued at approximately $1.2 billion, underscored the recognition of Heritage-Crystal Clean's value proposition and its significant role in the industrial and environmental services sector. As part of the agreement, each shareholder of Heritage-Crystal Clean stands to benefit from the acquisition, with J.F. Lehman & Company offering $45.50 per share in cash for every unit owned. This financial arrangement signifies the confidence the acquiring company places in the potential and growth trajectory of Heritage-Crystal Clean. There was a pretty decent premium attached to the company in my opinion, which now makes it trade at an earnings multiple of 21 compared to the sector's 17. In my opinion, I think the acquisition is a strong addition for J.F. Lehman & Company as the growth prospects and margins of HCCI are very good and the market drivers continue to push the top and bottom line higher.

Risks

Anticipating the normalization of base oil prices in the upcoming quarters, I also recognize the potential for a significant decline reminiscent of the events in 2020. Such a scenario could exert further downward pressure on spreads, subsequently impacting margins for the segment and placing added strain on the overall earnings outlook.

The company is driven somewhat by the fact that the market they are in is highly fragmented and there is a slight difficulty to enter it. But that also leaves HCCI in a position where they need to efficiently deliver their product and service to the targeted customer base. If there is too clear of a discrepancy between what they can do and what they actually deliver then there might be more companies willing to make the investments and move into the sector, which of course would improve the competitive landscape, but also potentially leave HCCI with less of a pricing power then what they currently had.

Financials

Looking at the balance sheet for HCCI I think it remains in good shape right now as the cash position has increased strongly since December 31, 2022, to $33 million. Besides that, the company has a long-term debt position of $103 million which I don’t think is too high to be worried are generating decent FCF and has a net margin of 9.5%, the highest it has been in the last 5 years for the company. With a net debt/EBITDA ratio of just 1.27, I think the company is in a good position to adequately pay down any current debt it may have. I want to highlight this, as by any chance the buyout doesn't go through or there are some disruptions, the business model and current condition of HCCI is in my opinion very good. Debt-wise, the company has never really had an unmanageable position in my opinion, as it's only been climbing steadily from $29 million back in 2018 to today's amount of $84 million. This all the whilst the net income went from $14.7 million in 2018 to $76 million. To me, this indicates a solid use of added debt to fuel earnings growth without overleveraging by any means. The financial stability and priorities the company has here align with mine, and I think HCCI will prove to be a great buyout opportunity for J.H.

Final Words

HCCI is being bought out for a deal valued at $1.2 billion with each shareholder getting paid $45.5 per share they own in HCCI at the time of the closing date. This doesn't leave a lot of upside room for an arbitrage play here unfortunately and is the reason I have them as a hold instead. Looking at the valuation, for example, the company is trading at a pretty high premium currently as the buyout came with a premium attached. Based on earnings, HCCI is trading 21% above the sector. That adds some potential downside risk for a correction if by any chance the deal would get prolonged and eventually canceled. For those that seek exposure to the sector but a more growth-oriented investment, then I think BrightView Holdings, Inc. ( BV ) is looking quite good currently at an earnings discount of 33% to the sector. The company seems solid with gross margins of nearly 25% and good earnings outlooks of $1.03 per share by 2025.

The company is solid based on financials and the market conditions which are propelling growth forward for the business, but unless there was a lower anticipation of the market seeing the deal go through then I won't be buying, unfortunately. Nonetheless, HCCI is a strong company, and holding shares until the close seems reasonable though.

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