Price $58 (at time this was written)
Estimated fair value $50
Shares Outstanding 60M
Market Cap $3.5B
Total debt $1.4B
Ent Value $4.9B
In our view, CLH is out over its skis, having made a (classic) mistake of acquiring (sexy) business at high multiples near the peak of the cycle, attracted most likely to its own success in its core business. I think the word is “hubris”, something the Greeks wrote about many many years ago. Recommendation: SHORT.
Since its founding in 1980 by CEO Alan McKim, Clean Harbors (CLH) has been a major consolidator
within hazardous waste industry. However, since 2009, it has "di-worse-ified" via acquisitions into non-core / non-waste / oil and gas field services that damage the attributes that had previously made it a great investment. These acquisitions face cyclical headwinds.
The good news is that hazardous waste is a “moat” business (though still procyclical). The waste business is characterized by tight regulations, high fixed costs, substantial
land / asset development costs, and significant investments in transportation and
logistics that protects it from outside
competitors, provides pricing power and reasonably strong free cash flow.
However, it is not as defensive as one might think given its exposure to cyclical
industrial businesses that generate waste, such as mining, chemicals and energy.
Historically, the waste business – part of the "Technical Services" segment that includes landfill and incinerators – contributed around 45% of revenues and EBITDA. But with recent acquisitions, the contribution is likely to drop closer to 25% (and if it doesn't, it's b/c the acquisitions are not pulling their weight).
In addition to its waste
management business, CLH also has a Field Services business that helps
institutions and companies manage the remediation and cleanup of their environmental
waste, be they school labs, PCB’s, refineries, pipeline spills, etc. The Field
Services business has a base business of stable recurring revenue and single
digit / low double digit margin maintenance contracts and a higher margin / highly
unpredictable disaster management piece. These services help the bottom line
and feed capacity into the landfill and incinerators.
But recent acquisitions yield di-worse-ification.
Not enough to leave the waste services business alone, CLH has still another
business - in fact it has four other businesses - and these additional services
are the catalysts to our negative call on the stock.
These four business are Industrial
Services (refinery turnaround, lodging and oil sands region maintenance),
Oil/Gas Field Services (oil sands and Baaken shale exploration), and with the recent
acquisition of Safety Kleen, the largest re-refining capacity in N. America and
a national parts cleaning business.
We outline in more detail our negative
views on the oil/gas services business and the Safety Kleen acquisitions but on
the latter issue simply note;
the core CLH business is paid to take waste
from customers in a market where it is a price maker while SK pays for
waste to convert into a commodity product as a price taker and unfortunately
in a market where supply capacity is expected to double. This is not an attractive model.
Despite this diversification, the stock
continues to trade as if it’s still a highly protected non-price sensitive
business. But it is no longer that kind of business. Historically, the waste business – including the landfill, incinerators - and the field services pieces together contributed between 70% and 80% of revenues and EBITDA. However, with these additional business, contribution from the highly protected, high free cash flow generating business, now contributes by our estimate just 35% of revenues and 45% of segment EBITDA (before unallocated corporate). Investors have not digested these changes.
The capital structure furthermore puts
the company at risk. The expansion since 2009 into non-core business was primarily
debt enabled and has lead to a capital structure that is ~100% debt / equity,
50% debt / total cap and 3x debt to annualized EBITDA. On one hand, it is aligned
with the median for the rest of the waste services industry. On the other hand,
no one else in the waste services peer group has the same exposure to
procyclical industrial services as CLH.
Slowing core growth. The company is not
transparent enough to provide organic vs acquired growth and this lack of
disclosure masks the precise decline in core revenues and earnings. But we have
seen negative core growth since 2010 when EPS from continuous operations peaked
at $2.44 before declining to $2.23 in 2011 and $1.87 in 2012 (after backing out
a one-time tax benefit). Over that time EBITDA grew from $315 / $350 / $383M in
2010 / 2011 / 2012, with the bulk from 2010 to 2011 from the one-time benefit of
the gulf coast clean-up in 2010 and in 2011 the acquisition of Peak Energy
(~$25M in acquired EBITDA).
Volume concerns in the core landfill
business. EPA data indicate a consistent decline in volume at CLH’s handling /
incineration facilities during the recession. We expect a continued arrest in
mine-related production concurrent with the easing of mineral prices (with
these high fixed cost business, it’s either on or off). What’s strange about
the data analysis – and something we need to better understand – is why revenues
in the Technical Services segment has no apparent relationship with volume. (We
have reached out to EPA and they indicated that the data should be accurate).
Waste Volumes Processed by CLH Facilities
vs Technical Services revenues
Source: EPA & Company Reports
Value destructive acquisitions that
increases risk in the business model and cash flows. The company has
historically grown via acquisitions in its core waste markets. However,
beginning in 2009 and more substantially in 2011 and 2012, acquisitions moved
outside of “bolt on” acquisitions in core cash flow generating waste markets
into non-related, cyclical and highly competitive oil/gas services markets via
Peak (energy and gas drilling) and lower margin re-refining markets via Safety
Kleen.
Headwinds – and there are several - in
the oil/gas services business. These include rig count reduction from low
natural gas prices in the Baaken shale regions, current and expected future production
declines in the Canadian oil sands due to the combination of demand reductions
from the US (higher CAFÉ standards, as we’ve seen in past cycles), more
domestic production in the US, and the eventual resumption of lower priced imports
from Venezuela (heavy oil similar to what we import from Canada). The
derivative impact of lower production in Canadian oil sands adds a negative
impact on the Industrial services / lodging business in that region.
Overall string of low quality earnings.
Adjusted net EBITDA over the last three years was $1B while FCF over the same
time frame was $268M. We view the delta as a symptom of low quality earnings
and in fact DSO’s expanded from 74 days in 2010 to 95 days in 2012 (28%,
roughly in line with the 26% growth in revenues over the same time frame).
Another area of concern on earnings quality is the roughly $170M (pre Safety
Kleen acquisition) accrued closure and environmental remediation liabilities.
This represents roughly 12% of total liabilities. The company is required to
account for future expenses of closing and remediating landfills based on
expected costs from a third party provider. Since CLH performs the
closure costs on its own, this account is persistently overstated.
CLH multiples and leverage ratios remain in
line with its environmental services peer group. However, the due to acquisitions
the dynamics of the business have changed. The core “Technical Services”
segment (i.e. landfill and incinerators) represented just 25% of revenues in
2012 on a pro-forma basis (assuming SK acquisition occurred in beginning of 2012).
The company shares a valuation and debt/equity ratio with its landfill /
incinerator peers but has cash flow dynamics that have strayed from its peers
concurrent with increased risk in its business model.
Source: Factset
Operationally, the company’s margins have
lagged peers on a trailing 12-mos basis. This situation is likely to persist
given the acquisition of the lower margin SK business.
Source: Factset
And finally, we see little opportunities
for organic revenue growth. The company is not particularly well positioned in
the wet gas regions to benefit from the “shale gas” explosion, positioned
around and to dry gas clients. It’s industrial and oil/gas services business
are clustered around the oil sands regions where price declines have already
halted certain construction projects and will likely lead to decreased
production growth. We fear further compression of organic volumes driven by
lower commodity prices negatively impacting the metals mining industry, which
is the largest producer of hazardous waste processed by third party facilities
in the country.
Given my forecast, I estimate a fair
value using peer group comps against my forecasts of ~$50 
BUSINESS DESCRIPTION
Based in Norwell, MA and incorporated
1980, the company reports four organic segments with two additional segments
that result from the Safety Kleen acquisition:
·
Technical services.
hazardous materials mgmt. includes incinerators, landfills and wastewater and
other treatment facilities
·
Field services. scheduled or (mostly)
emergency field and offsite cleanup services, includes tanks, decontamination,
remediation and spills
·
Industrial services. Scheduled
asset maintenance services at refineries, chemical plants, oil sands facilities
and other industrial facilities cleaning as well as catalyst handling and
decoking + lodging / drill camp accommodations in the oil sands
·
Oil & Gas field services. fluid
handling, equipment rentals, exploration, mapping, directional boring to
oil/gas and power … entered business through acquisitions of Eveready and Peak
Energy
·
Re-refining. (SK) owns and
operates two oil re-refineries in East Chicago, IN (largest in N. America) and Breslau,
ONT (largest in Canada). These two facilities represent approximately 60% of
the total oil re-refining capacity in North America. Total US capacity is
expected to double in next five years
·
Environmental services. (SK) Parts
cleaning, containerized waste, oil collection and RFO.
Broadly speaking, Technical + Field are
part of “CLH Environmental Services” and Industrial + Oil/Gas are part of CLH
“Energy and Industrial Services” I anticipate SK enviro svcs will be folded
into the industrial services segment and re-refining will remain on its own and
perhaps be sold eventually. [NOTE, I WAS WRONG! IN 1Q13 THE COMPANY FOLDED THE REPORTING
STRUCCTURE OF INDUSTRIAL AND FIELD SERVICES INTO ONE UNIT “INDUSTRIAL AND FIELD
SERVICES” AND REPORTED SK REFINING AND SK ENVIRONMENTAL AS STANDALONE SEGMENTS].
Stock valuation is driven by performance
in two segments: The core / cash cow landfill and incineration business with
additional upside from the higher beta oil/gas field services segment. Market
seems to discount one-off Field Service work and overall Industrial Services
business.
Historical (Pre-Safety Kleen) Segment
EBITDA Mix vs EV / Annualized EBITDA 2010-2012.
KEY CONSIDERATIONS: TECHNICAL SERVICES (LANDFILLS
/ INCINERATORS)
·
Landfill / incineration is a volume business. It is cyclical,
particularly on the hazardous waste side which is driven by industrial activity
·
It is not very price sensitive. I saw evidence of recent 8% price
increases to a large public client in 2012
·
It is difficult to permit and expand a landfill / incinerator, this
protects competitive behavior
·
In general, this is a great business with low growth and stable
margins
·
However, in the famous words of Peter Lynch, I think the company
risks “diworsification” given recent acquisitions to non-core businesses
Top-10 industries (2011) transferring
hazardous waste to offsite RCRA C and other landfills
Largest disposers are metals / mining +1B
lbs but potential to decline on lower
resource prices, electrical utilities ~600M lbs (but declining on conversion to
NG and reduction and coal and still prob not a driver of CLH revenues, and
chemicals ~450M lbs and very strong potential growth area on NG expansion /
availability
Total Transfers of Hazardous Waste to
Offsite Facilities (1991-2011 All US / All Industries) - note cyclical decline.
Offsite disposal is small but growing
percentage of total released environmental waste.
Hazardous Waste / Solvent Recovery Industry
trends –diversion from waste stream to recycling a likely driver of SK
acquisition
Shift towards more recycling is a benefit
– and perhaps a justification – for the environmental services portion of the
SK acquisition. It draws to my mind the possibility that CLH sells off the
re-refining assets to HCCI or another pure player.
KEY CONSIDERATIONS: FIELD SERVICES
Excluding emergency response work, this
is a $200M -$240M annual revenue business with a core high S/D or low teen
EBITDA margin. The benefit from ER work is twofold; first, it has high
incremental margins in the 20% - 30% range. Second, it scales the fixed costs
of the business, improving margins on the base business as well.
However, for obvious reasons (weather and
unexpected disasters), the segment is impossible to model. Regardless, the market
seems to look completely past the impact of the ER business anyway. It is not a
material reason to own the stock.
This segment compares to Pike Electric
Corp (PIKE), which does post-hurricane / post-storm related electrical and
transmission line repair and cleanup work. PIKE is a perennial market laggard
with a mid-single digit ~7x EBITDA multiple.
KEY CONSIDERATIONS: INDUSTRIAL SERVICE
This is a fixed asset services /
maintenance business in contrast to Field Services, which is a mobile business.
Maintenance / industrial services at refineries, chemical plants, oil sands
facilities, pulp and paper mills, and other industrial facilities cleaning such
as high pressure chemical cleaning, catalyst handling and decoking + lodging /
drill camp accommodations in the oil sands
Good proxy for the business – lodging and
oil sands industrial services – is CE Franklin, which National Oilwell Varco
acquired in 2012 for ~8x EBITDA. I also look to TISI and URS / Flint Energy
Services as comp.
Headwind as per negative news out of TISI
>> “The revised guidance reflects disappointing results in Team's
historically weak third fiscal quarter due primarily to lower than expected
revenues from its Canadian and European business units as well as a now
anticipated slowing of business growth in the fourth quarter due to the
expected timing of large turnaround projects.”
Also, the headwinds to the oil/gas
services business outlined above will negatively impact this segment going
forward.
KEY CONSIDERATIONS: OIL / GAS SERVICES
Fluid handling, rentals, exploration,
mapping, directional boring
Many many headwinds …
New entrant >> Why would anyone use
them for this???
Rig counts negatively impacted by low
natural gas prices
Political issues around XL pipeline
Heavy competition and pricing pressures
HEK results >> “As expected, the
industry related to our shale business slowed in the second half of 2012,
particularly during the fourth quarter. Activity declines exceeed normal seasonal
factors, which we believe was a function of drilling efficiencies pulling our
customers’ capital expenditures forward in the year. Working closely with our
customers, we planned for this pullback and reduced our capital expenditures,
which totaled $11.8 million for the second half of the year, and in turn were
able to grow our cash position in both the third and fourth quarters.”
SAFETY KLEEN ACQUISITION
12/28/12 CLH acquired SK for ~$1.3B cash
utilizing $300M cash on hand + $370M from equity offering financed the purchase
through a combination of approximately $300.0 million of existing cash, $370M
from 6.9M share equity offering ($56/share) and $589M from a private debt
offering of 5.125% sr unsecured notes (due 2021).
SK acq valuation reflected 7x annualized
2012 EBITDA of $190M.
SUMMARY THOUGHTS
Inputs to re-refined oil now a cost vs a
revenues
Regulations lead to shift to lower margin
aqueous cleaning market as solvents legislated out
Re-refining shifts model to higher
volatile earnings
Have been here before? Laidlaw acquired the original Safety-Kleen
business in May 1998, combining the collection and processing infrastructure of
the original Safety-Kleen business with Laidlaw's waste disposal assets
(landfills, incinerators, etc.). The proposed financial and operational
benefits of the merger were never realized. As a result, in June 2000 our
predecessor company filed for Chapter 11 bankruptcy protection.
Business Overview
SK is hq’d in Richardson, TX and is the largest
re-refiner and recycler of used oil in North America and a leading provider of
parts cleaning and environmental services to commercial, industrial and
automotive customers. Prior to the acquisition, SK reported two segments
Segment 1 = Re-Refining.
SK owns and operates two oil
re-refineries. One, in East Chicago, IN, is the largest in N. America and the
other, in Breslau, ONT is the largest in Canada. These two facilities represent
approximately 60% of the total oil re-refining capacity in North America.
In 2012 the company collected roughly
200M gallons of used oil and refined roughly 160M gallons. It recently
completed a 10M gallon expansion at the Breslau facility, which cost $30M in CAPEX
($3 / gallon) and a third 50M gallon / $100M ($2 / gallon CAPEX) facility is in
the development stages, proposed for the Gulf Coast and expected to complete in
1H15. >> CFO SAYS THIS WON’T HAPPEN; THEY ARE NOT BUILDING THIS
Over the last two years, SK generated
roughly $0.70 EBITDA / gallon of re-refined oil. This is below the industry
target (as per recent article see below).
Re-refining is largely a regional and
commodity business driven by proximity to inputs (used fuel oil). Competitors
include Evergreen Oil, Inc., HCCI (Heritage-Crystal Clean, run by former SK
executives and pure play publicly traded re-refiner) and NAL.T (Newalta Corp.)
Volume capped by capacity. Price driven
by commodity prices. “Re-refined prices and margins correlate with movements
in the Independent Commodity Information Services—London Oil Reports (ICIS-LOR)
rate, which is quoted weekly for base oil in Europe, Asia and North America.
Higher ICIS-LOR yields higher price and margin. RFO price is affected by
changes in the US Gulf Coast No. 6-3% oil index (“6-oil index”), which measures
the price of heavy fuel oil. Higher 6-oil index yields higher RFO price and
margin.”
Segment 2 = Environmental Svcs.
These are mobile operations / services
around the fixed based of re-refining. These mobile operations include: parts
cleaning, containerized waste services, RFO. This segment includes the costs of
collecting reused oil.
Parts cleaning. Both solvent and aqueous
cleaning. Business is transitioning towards aqueous cleaning, which reduces
amount of waste to landfills. Company has exposure to aqueous work through a
50% JV with Dwight and Church. We recycle all of the used mineral spirits
solvent that we collect from our parts washers and return it to our customers
as clean solvent, which accounts for more than 60% of our solvent servicing
requirements and we believe provides a cost advantage relative to the use of
only virgin solvent for parts washer servicing. We dispose of all of the used
aqueous fluid that we collect through various disposal channels.
Containerized waste services / Oil
collection. “While in the past we have charged customers to collect and
remove their used oil, with increases in oil commodity prices, most customers
now require us to pay them for their used oil.”
Recycled Fuel Oil (RFO). Revenues from
RFO represent direct sales of RFO to external customers. Movements in the
price of RFO are generally correlated with movements in the 6-oil index. == U.S.
Gulf Coast No. 6—3% oil index, measuring changes in the price of heavy fuel oil.
Total Project Management. Revenues from
total project management represent fees charged for various services provided
to our customers, such as chemical packing, on-site waste management,
remediation, compliance training and emergency spill response or for the
service of selecting and managing pre-qualified third party contractors or
internal staff to provide such services. Fees charged are generally based on
the duration of the project and the materials provided for the project.
Other Products and Services. Revenues
from other products and services, such as degreasers, glass cleaners, thinners
and hand cleansers and vacuum services represent sales of the relevant products
and fees charged for the relevant services.
