SRCL - Stericycle: Conservative Guidance Leaves Room For Positive Surprises

2023-04-10 10:35:02 ET

Summary

• Stericycle's actual organic top line growth for FY 2023 should turn out to be better than its +3%-5% guidance, considering the likely recovery in elective surgery volume.
• SRCL's expectations of weaker margins and an earnings decline this year seem overly pessimistic, as inflationary pressures have already begun to ease.
• I retain a Buy rating for Stericycle, as I think that SRCL's conservative guidance leaves room for positive surprises which could re-rate its shares.

Elevator Pitch

My rating for Stericycle, Inc.'s ( SRCL ) shares is a Buy. I reviewed Stericycle's financial performance for the third quarter of the prior year with my earlier November 10, 2022 article for the stock.

In this latest write-up, I highlight that SRCL has been way too cautious in setting the company's 2023 top line and bottom line guidance. I think that Stericycle can surprise investors and analysts in a positive manner with above expectations results for the current fiscal year. SRCL's key valuation multiples are currently below their respective historical averages, and a positive re-rating of Stericycle's valuations is highly probable if the company can deliver revenue and earnings beats in 2023. This explains why I have made the decision to stick with a Buy rating for SRCL.

SRCL's Organic Revenue Growth Guidance

At the company's FY 2022 results briefing , SRCL disclosed its organic sales growth guidance of +3%-5% (mid-point of +4%) for the current year, which excludes the effects of divestments or asset sales. Stericycle also specifically mentioned that "headwinds are factored into that (organic revenue growth guidance) range, and tailwinds could give us some opportunity." In other words, SRCL acknowledged that it has been pretty cautious with respect to its top line guidance for this year.

Stericycle's regulated waste and compliance services business segment and secure information destruction business segment accounted for 66% and 34% of the company's full-year FY 2022 top line, respectively as per its 10-K filing . The performance of SRCL's regulated waste and compliance services business, the relatively larger revenue contributor of the two segments, determines if Stericycle's 2023 organic sales can beat expectations. More specifically, elective surgery volume, that is positively correlated with medical waste, is the major factor impacting the growth of the regulated waste and compliance services business.

According to research published by healthcare research firm Altarum in March 2023, "hospital employment" has already recovered to the "level of three years ago" prior to COVID-19. This means that the lack of manpower during the worst of the pandemic which led to a significant deferral of elective surgeries is likely be much less of a headwind in 2023. As such, I think that the actual volume growth for the regulated waste and compliance services business and the overall revenue expansion for Stericycle in this year is most probably going to surpass the market's expectations.

Earnings Outlook For Stericycle

Stericycle's FY 2023 bottom line guidance is conservative, just like the company's top line expectations outlined in the prior section of the article.

The mid-point of SRCL's guidance points to the company achieving an earnings per share or EPS of $1.90 for FY 2023. In comparison, Stericycle's FY 2022 headline EPS and normalized EPS (adjusted for the impact of divestments) were higher at $2.04 and $1.94, respectively. Considering Stericycle's guidance of a +4% organic revenue growth and lower earnings in FY 2023, the company is expecting margin contraction for the current year. Notably, the company noted at its FY 2022 earnings call that it assumed inflation "persisting" in FY 2023 as part of its bottom line guidance.

A March 31, 2023 Seeking Alpha News article cited comments from "Surveys of Consumers Director Joanne Hsu" highlighting that "inflation expectations for the year ahead dipped to the lowest reading since April 2021." This implies that the negative impact of inflationary cost pressures on Stericycle's profit margins might turn out to be much milder than feared. Therefore, my opinion is that SRCL's actual FY 2023 profit margin and earnings could likely surprise on the upside with inflation easing.

Stericycle's Profitability Improvement For The Intermediate Term

SRCL's medium term financial guidance implies that the company is targeting to deliver a +13%-17% EBITDA CAGR for the FY 2023-2027 period on the back of a +3%-5% top line CAGR during this same period. The faster EBITDA growth expectations relative to its top line expansion suggest that Stericycle expects to achieve a substantial improvement operating profit margin in the coming years; SRCL's EBITDA margin could be as high as 23% (versus 16% in FY 2022) based on the company's intermediate term sales and EBITDA growth guidance.

In my view, Stericycle is well-positioned to witness meaningful profitability improvement in the mid term due to three key factors. Firstly, SRCL has plans to complete the deployment of its new Enterprise Resource Planning or ERP system in its core US market by the end of this year. Secondly, Stericycle has been making changes to key terms of its new contracts with clients to ensure that it has the ability to pass on cost increases with greater ease in the future. Thirdly, SRCL has been optimizing its portfolio mix in recent years with a focus on selling non-core businesses with inferior margins.

Valuations Multiples For SRCL Are Below Historical Averages

Stericycle currently trades at consensus forward next twelve months' EV/EBITDA and normalized P/E multiples of 13.0 times and 21.5 times, respectively as per S&P Capital IQ data.

As a comparison, SRCL's 15-year mean consensus forward next twelve months' EV/EBITDA and normalized P/E ratios were 14.2 and 24.0 times respectively. Stericycle's below-average valuation multiples indicate that the market has reasonably low expectations of the company's financial performance in the near term.

Closing Thoughts

Based on my analysis, Stericycle is in a good position to report better than expected financial results for 2023 on the back of a recovery in elective surgery volume and the easing of inflationary cost pressures. This supports my bullish view of SRCL's stock.

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