SRCL - Stericycle: Watch Deleveraging Efforts And Rising Fleet Expenses

2023-09-05 11:59:49 ET

Summary

• Stericycle has reduced its leverage ratio significantly from 3.28 times at the end of 2022 to 2.70 times as of June 30 this year.
• Higher than expected fleet costs hurt SRCL's Q2 2023 financial performance, but Stericycle intends to pivot to a fleet ownership strategy in due course.
• I leave my existing Buy rating for Stericycle unchanged, in view of an improvement in SRCL's financial position and the potential for lowering its future fleet expenses.

Elevator Pitch

My Buy investment rating for Stericycle, Inc. ( SRCL ) shares stays unchanged.

I previously highlighted that Stericycle could potentially deliver "positive surprises" associated with "its financial performance and portfolio optimization activities" in my earlier article for SRCL published on June 21, 2023.

With this current write-up, I touch on SRCL's success in deleveraging, and the opportunity for the company to make the shift to a fleet ownership strategy.

Stericycle managed to lower its leverage ratio to under 3 times, or more specifically to 2.7 times by the middle of this year. I am of the opinion that SRCL deserves to trade at a higher P/E valuation multiple, taking into account its improved credit risk profile. Separately, SRCL is well-positioned to achieve lower fleet expenses in future, as it has the intention of capitalizing on its robust financial position to own a greater proportion of its fleet going forward. I still have a Buy rating for SRCL in consideration of these positive factors highlighted above.

Reducing Financial Leverage

Stericycle has made significant headway in reducing the company's financial leverage.

Net debt for SRCL was lowered by -12% from $1,461 million as of the end of last year to $1,279 million at the end of June this year as indicated in the company's second quarter earnings presentation . At its Q2 2023 results call , Stericycle disclosed that it received approximately $84 million from the sale of specific businesses in the recent quarter, which was utilized to repay part of its outstanding debt.

As a result of its deleveraging efforts, Stericycle's leverage ratio decreased from 3.28 times as of December 31, 2022, to 2.70 times as of end-Q2 2023. This is a meaningful development in a number of ways.

Firstly, SRCL had met its target of registering a "three times (or below) debt leverage ratio in the first half of 2023" as mentioned at the company's Q1 2023 earnings briefing . It is always reassuring for investors to know that a company can deliver on what it has promised to achieve, so Stericycle's recent success in deleveraging increases investors' confidence in the management's execution capabilities.

Secondly, Stericycle's leverage ratio of 2.70 times as of June 30, 2023, was the lowest that it has been in the past eight years. In contrast, SRCL is currently trading at a consensus forward next twelve months' normalized P/E ratio of 21.7 times (source: S&P Capital IQ ), and that is below the stock's 10-year historical average forward P/E multiple of 22.1 times. In other words, the market doesn't seem to give Stericycle sufficient credit for its stronger financial position.

Thirdly, SRCL's lower net debt and leverage ratio are expected to translate into a decrease in finance costs. In specific terms, the Wall Street analysts project that Stericycle's interest expense will decline by -9% to around $70 million in full-year fiscal 2024 as per S&P Capital IQ's consensus data.

In summary, Stericycle has done the right thing by deleveraging aggressively. The company's improved balance sheet should lead to lower interest costs, a higher valuation multiple, and greater investor confidence as mentioned above.

Tackling Rising Fleet Expenses

SRCL's normalized operating income decreased by -7% YoY from $82 million for Q2 2022 to $76 million in Q2 2023. The company had noted in its quarterly results announcement that an increase in fleet costs was one of the key factors contributing to its operating profit decline for the most recent quarter.

Fleet expenses as a proportion of top line for Stericycle rose by +0.7 percentage points YoY in the second quarter of the current fiscal year. At its Q2 2023 results briefing, SRCL specifically mentioned that fleet "cost pressures" are "up with reference to maintenance, vehicle repairs" and noted that "fees for returning some of those (rental) vehicles have been increased quite a bit."

In the preceding section of this article, I wrote about Stericycle's deleveraging efforts and the reduction in the company's financial leverage ratio. Given that SRCL is in a more comfortable financial position now, the company has the capacity to invest a greater amount of capital in various areas of its businesses including its fleet.

Stericycle had emphasized at the company's second quarter earnings call that "we eventually want to even get out of the leasing business" and "be able to start to buy some of the fleet." SRCL also previously highlighted at its Q1 2023 results call that it wishes to "get out of the rental business" and have "newer vehicles that will not have as much maintenance required."

It is clear that SRCL intends to move away from fleet leasing and pivot to a fleet ownership strategy in time to come. Stericycle's strong balance sheet means that the company has the financial strength to consider building up a fleet of its own to optimize fleet expenses for the future.

Closing Thoughts

Stericycle has been successful with its deleveraging efforts. Also, there is the potential for SRCL to improve its profitability by switching to a fleet ownership strategy which will translate into lower fleet costs. As such, I continue to be bullish on SRCL's prospects, and this translates into a Buy rating for the stock.

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