2023-03-31 12:17:40 ET
Summary
- In the near term, the company should benefit from carryover price increases and higher backlog conversion.
- In the long term, the company should benefit from the reshoring trends, decreasing captive incinerator capacity, and M&As.
- Valuation is reasonable.
Investment Thesis
Clean Harbors ( CLH ) is well positioned to benefit from carryover price increases from late last year and improved backlog conversion in the near term. Additionally, the company is expected to profit from long-term trends such as increased reshoring and decreasing captive incinerator capacity due to regulatory hurdles. Furthermore, CLH's stable business and low debt levels position it well to pursue tuck-in acquisitions.
Although margins may experience a slight decline in the near term due to a lower re-refining spread in the SKSS segment, the long-term margin outlook is good. The stock is trading at a reasonable valuation and is below its historical levels as well as a discount to its peer Republic Services ( RSG ). Therefore, I believe it is a good buy at the current levels.
Revenue Analysis and Outlook
Following the pandemic, CLH experienced robust revenue growth due to favorable industrial demand and the acquisition of HydroChemPSC in 4Q21. In 4Q22, the company lapped the anniversary of the HPC acquisition and adverse weather conditions in December. This resulted in a sequential deceleration in revenue growth, from 43.3% YoY growth in 3Q22 to 14.2% YoY growth in 4Q22.
Looking ahead, CLH is expected to benefit from increased backlog conversion in 1Q23. In 4Q22, the company experienced lower backlog conversion due to the extreme weather in December, which resulted in unplanned outages at Deer Park and El Dorado facilities. As a result, the backlog increased and should be converted in 1Q23, which should lead to higher revenue growth in the current quarter. Additionally, CLH implemented price increases across its businesses in the Environmental Services segment during the latter half of the year. The company should witness carryover benefits from these price increases in the first half of FY23. CLH also plans to continue to increase prices at a normal pace of 3-5% annually, which should further benefit sales.
In the medium to long term, CLH is expected to benefit from several fundamental drivers, including increasing reshoring trends and decreasing captive incinerator capacity due to regulatory reasons.
The recent government bills such as the IIJA and CHIPS Act, which aim to increase investment in manufacturing facilities and reshore operations to the US, are likely to drive higher demand for waste disposal services. CLH, with its national presence and scale, is well-positioned to benefit from this trend. While large manufacturers could theoretically build their own in-house waste treatment plants, there are significant challenges and costs associated with doing so. The facilities require various approvals, permits, and compliance with strict regulatory standards. Failing to meet these standards can result in hefty penalties and harm a company's reputation. A testament to this is 3M's ( MMM ) captive incinerator facility, where state officials fined the company for failing to meet regulatory requirements. Subsequently, 3M partnered with CLH for its waste disposal needs. Hence, the threat of the development of onsite waste treatment facilities is low, and companies operating captive incinerators should increasingly partner with CLH. To meet the increased demand and declining captive capacity, CLH recently started to build one more incinerator facility, which should increase the company's incinerator capacity by 8% by 2025.
In addition to the organic revenue drivers, CLH's stable waste disposal business model and low leverage make it well-positioned for inorganic growth. Waste disposal is an essential service, and because of regulatory obligations it cannot be deferred or replaced. Furthermore, the company's low debt level, currently at 1.9x net debt to EBITDA (as of 4Q22 end), provides a strong financial position that can facilitate tuck-in acquisitions and drive growth. The company recently acquired Thompson Industrial Services which should contribute to the company's revenue growth starting 1Q23 and I expect more M&A activities looking ahead. Overall, I'm optimistic about CLH's revenue prospects, and I believe that the company is well-positioned to weather any potential slowdown due to its resilient waste disposal business, favorable industry trends, and inorganic growth prospects.
Margin Analysis and Outlook
CLH experienced a 200 bps Y/Y adjusted EBITDA margin improvement in FY22, attributable to operating leverage benefits, higher pricing to offset inflation, and higher re-refining spreads.
For 4Q22, the adjusted EBITDA margin improved 190 bps Y/Y to 17.5%, driven by volume leverage in the ES segment, partially offset by lower margins in the SK sustainability solutions (SKSS) segment due to higher collection costs.
Looking ahead, the contraction in oil re-refining spreads may impact consolidated margins. However, the improved fundamentals of the ES segment and synergy benefits from the HPC acquisition should partially offset the headwind on consolidated margins.
The SKSS segment, which deals with re-refining and recycling oil products, saw significant margin improvement post-pandemic due to higher oil prices, resulting in better re-refining spreads. As base oil prices are now declining, the company should see normalization in re-refining spreads. However, I believe margins should still remain above pre-pandemic levels due to reducing the cost of oil collection thanks to the International Maritime Organization's 2020 regulation. The regulation prohibits the use of fuel in the shipping industry with a sulfur content of more than 0.5%, reducing the demand for used motor oil in coastal areas and helping companies like CLH procure used motor oil at cheaper prices or sometimes charge a service fee to take it.
While the SKSS segment's margins may normalize, the ES segment's margins should remain resilient due to continued demand and price increases. Furthermore, the integration of the HPC acquisition should yield ~$40 million in run-rate synergy benefits for the current year.
Overall, the company should experience a slight decline in margins in FY23 after a good run-up post-pandemic. However, post the normalization of margins of the SKSS segment in FY23, the company should again see a margin expansion in FY24 and beyond thanks to operational leverage from higher revenues and the use of more efficient assets, such as the new Kimpbell incinerator facility.
Valuation and Conclusion
The stock is currently trading at a forward EV/EBITDA of 9.38x, which is slightly lower than its five-year average of 9.86x as well as its peer Republic Services Group's 12.77x .
The business has several secular tailwinds, and management's execution also has been excellent. This coupled with the inorganic growth executive bodes well for the company's growth in the future. The company has grown its adjusted EBITDA at 19% CAGR over the last five years and management recently shared the company's FY2027 target on investor days where they anticipated doubling the company's EBITDA over the next five years.
Given the company's good growth prospects, stable business model, healthy balance sheet, good history of execution and growth, and reasonable valuations, I have a buy rating on the stock.
For further details see:
Clean Harbors: Good Growth Prospects At Reasonable Valuations