Waste is Good if You Are Clean Harbors

By j.a. graham - October 29, 2012 | Tickers: CLH, ECOL, WM | 0 Comments

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Clean Harbors (NYSE: CLH) cleans things up. The company is one of the larger environmental service companies in North America providing maintenance of industrial plants, expertise in handling environmental disasters, waste disposal and hazardous waste. The company also has a strong presence in energy on both the exploration and production sides. Clean Harbors was founded in 1980 by Alan McCoy who is still the CEO today.

In the 1970s and 1980s, industry growth benefited from a slew of new environmental laws by federal and state agencies to regulate existing hazardous waste management facilities and accelerate the clean-up under Superfund law. By the early 1990s, there was excess hazardous waste capacity after 20 years of aggressive expansion and less waste to fill it as industries generating waste worked to cut output and operate more efficiently. Even superfund site clean-up began to decline as projects were completed. That has created a competitive environment even today.

Clean Harbors operates in four segments

• Technical services
• Field services
• Industrial services
• Oil and gas field services

Technical servces

Technical services is the biggest, highest margin segment. It involves the collection, transport, treatment and disposal of hazardous and non-hazardous wastes.

Included services are:

• Resource recovery
• Incineration
• Landfill disposal
• Wastewater treatment
• Lab chemical disposal
• Explosives management

 Clean Harbors has a service centers that send trucks to pick up customers' waste on a schedule or on-demand. It ends up in permitted facilities that are usually company-owned. CLH is licensed to dispose of both hazardous and non-hazardous waste. Hazardous waste is nasty and dangerous and includes corrosive, ignitable, infectious, reactive or toxic substances. CLH provides final treatment and disposal of hazardous material that can’t be recycled. The facilities hold special permits allowing recycling, incineration, landfill, and wastewater treatment. The permits give them a moat and are a valuable asset.

Field Services

The field service crews and equipment go into the field either on scheduled contracts or in environmental emergencies. They provide:

• Site decontamination
• Remediation
• Spill cleanup
• Railcar cleanup
• Stain removal/surface prep
• Environmental emergencies—oil spills, hurricane cleanup
• PCB management/disposal

 The field services segment has seen an unusually quiet 2012 with no spills or weather events (hurricanes) requiring emergency response.

Industrial Services

 This is an industrial maintenance services segment and includes working with refineries, mines, upgrades, chemical plants, pulp and paper mills, manufacturing, and power generation facilities. Crews handle as-needed in-plant services to support ongoing cleaning and maintenance. Industrial requires specialized skills in plant outage and turnaround, decoking and pigging, catalyst handling, chemical cleaning, high and ultra-high pressure water cleaning, and large tank and surface impoundment cleaning.

Oil and Gas Field Services

 Exploration includes seismic data gathering -- mapping the optimum source (explosive placement) and receiver (information gathering) lines and then clearing and cleaning up the clearing process. They also drill shot holes to place the charges in for the seismic work. They sell directional boring services to support oil and gas companies and municipalities installing pipeline, fiber optic, cable, gas, and water and sewer lines.

 Part of oil and gas involves well completion and clean up. They treat frac-water and dispose of drilling fluids and solids. CLH technology manages liquids, solids and semi-solid material during the drilling operation, and the services include equipment rental for centrifuges and tanks. In active oil and gas wells, downhole production includes cleanout and maintenance to increase well production and efficiency. They can retrieve broken rods, clear out sand, break up emulsions with heat, clear hydrocarbon buildup with solvents, provide slickline services and more. Busy oil and gas drilling activity is good for business and the current decelerating energy demand is compressing margins and slowing revenue.

Since Q1 results were announced, Clean Harbors' price per share has been in decline and it’s largely due to the perception that their oil & gas business is cycling down and will continue to drop into Q3 and possibly Q4. The anticipated oil and gas underperformance has an outsized impact on the price per share. O&G has been the fastest growing segment both in 2011 and Q2 2012. Total exposure to energy across segments is estimated at 38%-- 14% is production; 11% is exploration; 13% is work for refineries. 

Quarterly percentage of revenue and margins by segment

Oil and gas business currently has no pricing power and competition is creating a weak pricing environment. Revenue continues to grow but it is largely acquisition driven. Margins are in decline and well below 2011 operating margins of 2011 21.7%; the damage from competitive pricing is substantial. The competition for clearing and cleaning sight lines, surveying and seismic drilling and data gathering jobs is high. It creates pressure on margins and that has been more evident as exploration slows and rig counts drop. The number of gas rigs is down 55% year-over-year, oil is up 31% and total US count is down 9%. The Canadian count is down by 151 rigs over last year – a 29% decline. The logistics of making such large equipment moves has been expensive both in time off the job and the expense of shifting a huge amount of oil and gas field equipment. CLH estimates it cost them $10-$15 million in Q2. The seasonal slowdown in Canada cost another $5 to $10 million.

 Q2 in O&G field services was weak. Around 3/4 of oil and gas business is in Western Canada and that makes CLH O&G extremely seasonal. Canada’s warm winter and early spring break up followed by a wet spring made the fields impassable and delayed work in Q2. The effects were evident in unusually poor margins in Q2 2012. O&G field service’s revenue tends to trough in Q2 and begins to trend up in Q4 and Q1 – the strongest quarters. The company is predicting a similar pattern in Q4 2012 and Q1 2013. Should rig counts continue to drop, these two quarters may be disappointing year-over-year even if they show improvement over Q2 and Q3 sequentially.

Fortunately, CLH has diversified operating segments and those are doing well.

Segment results

 In the technical services, incinerator utilization was over 90%. The U.S. locations were at 88% utilization and the Canadian Sarnia incinerator was essentially 100% utilized. The overall rate of 90% is down from 92% Q2 2011 as a result of a 17% increase in down days. High utilization is key to maintaining margins. Underutilized incinerators are expensive to run and maintain.

Landfills had an equally strong performance with volumes up 60% from activities in the Bakken oilfield. Q2 2012 was the second highest quarterly volume in Clean Harbors' history.

Field services segment had no major events i.e. disasters to work on but saw 9% growth from routine maintenance contracts.

Industrial services grew 27% with a mix of business including work in the oil sands region in Canada and high demand for plant services. Lodging has been a good business for CLH estimated at $200 million in revenue per year.

Balance sheet

Total cash at the end of Q2 was $306 million with debt at $523.4 million. Debt to capital was 35.3%. They were not overleveraged. The 2011 interest coverage ratio was 5.5X and 4.3X in Q2 2012. They have approximately $515 million in available cash and equivalents and are actively looking for acquisitions. In Q3, they will have a $26.5 million pre-tax charge for the early extinguishment of $520 million of their debt that was refinanced with a new bond offering in Q3.  The $800 million bond has a coupon of 5.25%--about 2.4% less than the coupon of the refinanced debt. They expect to save $12 million per year and the bonds mature in 2020. The $800 million will increase the debt ratio by 10% to around 45% debt to capital.

 The total accounts receivable decreased to $427.6 million at quarter’s end from $493.3 million. They continue to focus on collections and working capital management. DSO (days sales outstanding) was lowered to 75 days from the 80 days in Q1. The target DSO is 70 days or less and will take a few more quarters to realize. Historically, the current 75 days compares favorably to DSO over the years. If they reduce that to 70 days that would be a measurable improvement that would improve cash flow.

Cash flow

 CLH manages cash flow well considering the level of acquisitions made to create growth. They have used a combination of debt and equity and have kept debt levels at acceptable levels and not diluted shareholders excessively with follow-on offerings of stock to finance company operations.

In 2008, share dilution was 17%. The cash from shares was used to repay debt and make an addition to cash levels that was carried forward and used in 2009 for a small acquisition. CLH issued debt in 2011 and acquired Peak for $205 million. At the end of 2011, they still had high levels of cash. The debt/capital ratio was 35% at the end of 2011 and share dilution has been stable at 1.4% over two years.

 Use of working capital as it impacts cash flow from operations has been a positive over the years. As measured by CFFO/net income, CLH manages a ratio greater than one every year for the past six years. Net income is not consumed by mismanaged receivables and other working capital accounts.

Clean Harbors makes a lot of acquisitions. Peak was one of the largest in 2011 at $205 million. Peak was an addition to energy services – largely oil and gas drilling and production.

In addition, CLH spent $141 million for three more businesses in 2011:

• Part of a Canadian public company engaged in the business of providing geospatial, line clearing and drilling services in Canada and the United States

• All of the outstanding stock of a privately owned U.S. company which specializes in treating refinery waste streams primarily in the United States

• All of the outstanding stock of a privately owned Canadian company that manufactures modular buildings

 The acquisitions were integrated into the Oil and Gas Field Services, Technical Services and Industrial Services segments, but all are energy related. The 2011 business mergers added to energy and resulted in over-dependence on the energy cycle. They are now top-heavy in oil and gas and the result was a poorer than usual Q2 with undoubtedly more repercussions to come in Q4 and Q1 2013.  Guidance should be regarded with some skepticism.  CLH has had a few instances over the years of some very big misses resulting in negative surprises and share price declines.

 A good way to evaluate a serial acquirer is with a return on invested income. If a company overpays and has assets (especially high levels of goodwill) that are not paying their way, the ROIC may be lower than the cost of capital indicating the company is consuming cash and not creating much immediate value for shareholders. That is acceptable for a period in fast growing businesses that are reinvesting heavily in the business.

ROIC for Clean Harbors

The WACC  (weighted average cost of capital) for 2011 was 8%. The spread is widely positive. The ROIC was down slightly in 2011 likely due to the lack of sufficient time to fully integrate the businesses and their costs. I would predict the value might be lower again in 2012 if the energy cycle fails to turn up and provide high returns on the Peak acquisition.

Competition

Landfills, incinerators and permits to handle hazardous waste give them a moderate moat.

From Waste Management

All solid waste management companies must have access to a disposal facility, such as a solid waste landfill. The significant capital requirements of developing and operating a landfill serve as a barrier to landfill ownership.

Waste Management (NYSE: WM) has five hazardous waste sites compared to seven for CLH. WM is not a pure comparison as a collection is 62% of the $13.4 billion in revenue (CLH had $2 billion in revenue for 2011). Landfill is only $2.6 billion of $13.4 billion in revenue for 2011. Waste Management has broadened its business to include selling electricity generated from trash. This is not always a business plus--in Q2 WM lost 3¢ per share on lower electricity pricing. They do have one distinct advantage and are paying $1.42 in dividends for a forward yield of 4.4%. WM has been trading in an extremely narrow range over 52 weeks and offers a little more stability in its business and its price moves.

U.S. Ecology (NASDAQ: ECOL)is a more direct comparison to CLH, but is  a much smaller business with revenue of $155 million in 2011 and only four hazardous waste sites. They are more dependent on big one-off contracts than the more diversified CLH. They do have superior margins and pay a dividend. 

ECOL has property that is permitted to accept hazardous waste including radioactive material. This provides a moat -- owning property that has the capability of dealing with toxic garbage is not a commodity it is a privilege. It’s the same moat Waste Management and Clean Harbors have. A significant portion of ECOL's disposal revenue is discrete event business that varies widely in size, duration and unit pricing. Approximately 39% of their treatment and disposal revenue was derived from event business projects making them a little less predictable quarter to quarter.

Guidance

Guidance may be optimistic. In spite of Q2 slowing revenue growth and contracting margins, the company is reiterating 2012 revenue guidance. CLH maintained its previously announced annual guidance despite the oil and gas business being below expectations in Q2.

From the CC:

 We are confident in our prospects for the second half of the year, therefore we continue to expect 2012 revenues in the range of $2.2 billion to $2.25 billion and EBITDA in the range of $400 million to $410 million, which implies an EBITDA margin of greater than 18% for the full year. I should point out that this guidance is exclusive of any potential acquisitions.

 The business in O&G will have to get much better and the margins will have to recover.

 The company does intend to make more acquisitions and leaves the option open to close one before the end of the year. That would increase revenue and help them meet guidance. The recent $800 million bond offering gives them cash to work with. I would be looking for them to acquire businesses in the environmental segment and steer clear of energy. Unfortunately, opportunities in environmental are priced at high multiples the company hesitates to pay. It will take discipline and some deal making skills to keep from overpaying. Their acquisition strategy so far has created growth and value.

 Even though Clean Harbors at $48 is near a 52-week low after reaching a high of $72, buying now puts investors at risk of holding through two quarters that could see downward guidance and continued underperformance of the energy segment. The result would be rapidly deflating shares. Management has over-promised and under-delivered on a couple of occasions.

 In spite of the energy segment’s dismal Q2, the rest of the company continues to grow revenue and expand margins. At some point, O&G will be a plus again—unfortunately we can’t know when and I suspect management is being optimistic predicting recovery by Q4.  If they do miss, there should be an even better buying opportunity later this year or early in 2013. 

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