stericycle, inc. (nasdaq:srcl) july 2016...2016/07/13 · as the trend of industry consolidation...
TRANSCRIPT
Stericycle, Inc. (Nasdaq:SRCL) – July 2016
Article Title: “Stericycle: This Is Still A Good Short”
Recommendation: Short Stericycle (Nasdaq:SRCL) equity
Current Stock Price: $104.70
Target Stock Price: $65.00 (38% return)
Timing: 6 – 12 Months
Catalysts: Disappointing earnings, failure to integrate acquired businesses, accounting re-
statements
Summary Thesis
Stericycle is a waste management roll-up which has exhausted its growth opportunities in
its core business and has expanded into lower quality businesses
The company’s core medical waste business is facing limited growth opportunities and
margin pressures from the consolidation of its customer base
The acquisition of Shred-it in 2015 will likely continue disappointing investors as it is a
low quality business and its purchase was predicated upon synergies that have proven
difficult to realize
The acquisition of PSC in 2014 has exposed the company to a cyclical earnings stream
and has resulted in Stericycle receiving an adverse opinion from its auditor for material
weakness in internal controls
Continued earnings pressure and multiple compression could result in Stericycle’s stock
failing an additional 20% - 50%
Situation Overview
Stericycle (SRCL) was founded in 1989 as a medical waste management company in response to
the introduction of more onerous laws regarding the disposal of medical waste. In 1987, a leak
from a landfill resulted in hypodermic needles washing up over a 30 mile stretch of the Jersey
Shore. This environmental disaster known as “syringe tide” resulted in the Medical Waste
Tracking Act of 1988.
Capitalization Financials Valuation
Market Cap $8,890 2015 Sales $2,986 EV/2016E Sales 3.3x
Cash $46 2016E Growth % 22.1% EV/2015 EBIT 18.2x
Debt $3,152 2015 EBIT $658 EV/2016E EBIT 15.5x
Enterprise Value (1) $12,009 2015 Margin % 22.0% Price/2016E EPS 21.0x
(1) Includes $12.1 million of minority interest.
Source: Capital IQ as of 7/8/2016.
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Today, Stericycle continues to specialize in medical waste management but has expanded to
hazardous industrial waste, document shredding, outsourced medical call centers, and product
recall management. The company doesn’t provide revenue or profitability break-outs by product,
but below is my best estimate of what the mix looks like today.
Est. Revenue Mix Est. EBITDA Mix
Stericycle has used an acquisition-led growth strategy to build scale in its waste management
business and expand into other lines of business. Since becoming a public company in 1996, the
company has made 450 acquisitions to grow at a compound annual rate of 30%. Half of this
growth has been inorganic.
The acquisition strategy is to first acquire a regional waste collection network and then focus on
making tuck-ins of competitors in order to bring on additional customers. The company’s stated
IRR hurdle rate is low-mid teens (which is quite low). The company believes that once it builds a
strong customer list it can cross-sell its services (waste management, compliance training,
document shredding, ect.) to make the acquired businesses much more profitable.
Stericycle has had a great deal of success rolling up the medical waste industry. By 2003, the
company was generating over $400 million in revenue and had a 31% EBITDA margin. In 2003,
the company entered the sharps management (hypodermic needles) and pharmaceutical returns
businesses. In 2008, the company began expanding its medical waste business abroad through
acquisitions. In 2010, Stericycle entered the outsourced medical call center business.
While the company had expanded beyond its core service of handling medical waste, it was still
focused on health care oriented services and maintained strong profitability and return on
invested capital (ROIC). However, in 2012 Charles Alutto took over as CEO and changed
strategic direction. Alutto expanded SRCL’s hazardous waste business by acquiring PSC in 2014
and expanded into document shredding by acquiring Shred-it in 2015. These recent acquisitions
were much larger and transformational in nature. These acquisitions have been extremely
disappointing and appear to be significant capital allocation mistakes which have impaired
shareholder value.
US Medical Waste37.0%
Intl. Medical Waste16.9%
Shred-it20.6%
Haz. Waste17.3%
Call Centers
5.5%
Recall2.7%
US Medical Waste56.6%
Intl. Medical Waste9.7%
Shred-it18.9%
Haz. Waste8.6%
Call Centers
2.9%
Recall3.4%
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As a separate capital allocation issue, the company has spent over $300 million buying back
share above its current stock price over the past 2 years. This includes recent share repurchases at
average prices in the $120 - $140 price range; the stock currently trades at $104. The company
still has a large share repurchase authorization which it is likely using to purchase shares as the
stock price continues to collapse.
Stericycle believes its competitive advantage is its ability to build business density through its
acquisition machine. This business density works 2 ways:
1) SRCL is primarily a logistics company transporting waste and by having a dense
customer base it can more efficiently serve its customers.
2) By cross selling other waste and business management services, SRCL creates
more sticky and profitable customer relationships.
Outside of the company’s ability to build business density, SRCL recognizes that its business has
low barriers to entry because anyone can pick up and deliver waste to a processing facility.
Despite the low barriers to entry, Stericycle has managed to create a very strong customer
ecosystem within healthcare waste management and compliance.
However, I believe that Stericycle has lost it way with its recent expansions into hazardous waste
and document shredding. The company has entered businesses outside of its core competency
that are more competitive, more cyclical, more capital intensive, and less profitable. As a
result, the company is facing margin compression and declining ROIC. Margins peaked in
2009 before Stericycle expanded into call centers (2010), hazardous waste (2014), and
document shredding (2015).
Stericycle’s Medical Waste Business Faces Headwinds to Profitability
With ~54% of total sales of ~66% of EBITDA, medical waste is SRCL’s most important
business and crown jewel asset.
Stericycle has multi-year contracts with physicians, clinics, and hospitals to collect and dispose
their regulated medical waste. Regulated medical waste is defined by the EPA as “any solid
waste that is generated in the diagnosis, treatment, or immunization of human beings or animals,
in research pertaining thereto or in the production or testing of biologicals”; examples include
needles, blood, surgical specimens, pharmaceuticals, ect. Stericycle provides its clients with
Historical Financials
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 LTM
Revenue $609 $790 $933 $1,084 $1,178 $1,439 $1,676 $1,913 $2,143 $2,556 $2,986 $3,197
Growth % 18.1% 29.6% 18.1% 16.2% 8.7% 22.2% 16.4% 14.1% 12.0% 19.3% 16.8% 20.7%
Gross Profit $268 $350 $418 $510 $582 $706 $802 $902 $1,017 $1,151 $1,328 $1,424
Margin % 44.0% 44.3% 44.8% 47.1% 49.4% 49.0% 47.8% 47.1% 47.4% 45.0% 44.5% 44.5%
EBITDA $191 $233 $272 $316 $365 $447 $510 $553 $645 $717 $786 $816
Margin % 31.4% 29.4% 29.2% 29.2% 31.0% 31.1% 30.5% 28.9% 30.1% 28.1% 26.3% 25.5%
EBIT $170 $206 $241 $282 $325 $394 $444 $477 $556 $612 $658 $667
Margin % 27.9% 26.0% 25.9% 26.0% 27.6% 27.3% 26.5% 24.9% 26.0% 24.0% 22.0% 20.9%
Adj. EPS $1.07 $1.22 $1.44 $1.74 $2.07 $2.52 $2.78 $3.03 $3.54 $3.92 $4.21 $4.23
Growth % 16.9% 13.9% 18.4% 21.1% 18.4% 22.0% 10.2% 9.1% 17.0% 10.6% 7.3%
ROIC % 11.8% 11.3% 10.7% 11.5% 10.6% 10.7% 9.9% 9.5% 10.1% 9.9% 6.5% 6.5%
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special containers for the various types of waste and has scheduled pick-ups (generally once a
month).
Stericycle operates a nationwide fleet of trucks which pick up waste and transports the waste to
company-owned facilities where the waste is treated either by autoclave (hot steam) or
incineration. Once the waste has been processed, it is then transferred to third-party landfills.
Stericycle serves over 1 million customers worldwide and no single customer accounts for more
than 1.5% of total revenue. Customer retention is over 90%. The company primarily serves small
business accounts (SQ) and over time has focused on growing its customer base of these small
businesses because they are significantly more profitable than SRCL’s institutional accounts
(LQ) such as hospital systems. Over the past 20 years, the customer mix has shifted from 33% of
sales coming from small businesses to over 60%.
Source: SRCL Q1 2016 Earnings Presentation.
Note: The above chart depicts the customer base for the entire company, not just medical waste.
The profit margin differential in serving small accounts vs. large accounts is quite large. Small
accounts generate an average gross margin over 50% vs. low 20% range for large accounts. The reason there is such a wide gap is because small medical practices are less equip to manage
regulatory requirements and SRCL can effectively sell additional services such as compliance
training/consulting, document shredding, and outsourced phone services. Larger accounts are
also better at negotiating lower prices for waste management.
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Source: SRCL Q1 2016 Earnings Presentation.
The medical waste management business is benefiting from secular tailwinds in the US from the
expansion of the healthcare system due to an aging demographic and universal health insurance
coverage. There is also pressure in the US healthcare system to reduce costs which has resulted
in more outsourced contracts awarded to companies like SRCL. As a result of these tailwinds,
Stericycle has managed to organically grow at a mid to high single digit rate over the past 25
years.
However the same cost pressures and regulatory trends that have encouraged outsourcing
have also led to a trend of consolidation among hospitals and private practices which
represents a significant profitability headwind to Stericycle. According to KaufmanHall
(http://www.kaufmanhall.com/about/news/hospital-merger-and-acquisition-activity-up-sharply-
in-2015-according-to-kaufman-hall-analysis), hospital M&A is up 70% since 2010. Small
physician practices have also been selling to hospital systems to mitigate regulatory costs.
(http://www.startribune.com/why-local-doctors-are-selling-their-practices-to-national-
companies/383334071/).
As the trend of industry consolidation continues, Stericycle will see its margins compress as it
moves from high margin small accounts to low margin big accounts. Stericycle is already well-
penetrated with small practice healthcare businesses leaving little room for the company to
generate growth to offset the structurally declining margins. The trend of lower margins is
observable: SRCL’s margins peaked in 2009/2010 and have been steadily compressing each
year.
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CEO Charles Alutto acknowledged the headwinds from customer consolidation on the Q1 2016
earnings calls: “We are starting to observe some longer sales cycle at these hospital-affiliated SQ
customers. Remember the decision-maker changes a little bit when the hospital acquires a
doctor's practice, where we normally deal with an office administrator or office manager. We are
now dealing with more personnel from the hospital. So we believe we'll see some pricing
pressure on hospital-affiliated SQ account as these contracts come up for renewal.”
In recent years the company has de-emphasized the domestic healthcare waste management
business by acquiring international assets and expanding to other products. This capital
allocation focus sends a clear signal that the company doesn’t see a bright future in the domestic
healthcare waste management business and is working very hard to diversify away from the
segment.
Stericycle’s foray into expanding internationally hasn’t proven to be very valuable. Despite over
200 acquisitions made internationally since 2001, SRCL has not developed a very profitable
business outside of the US. Currently, ~75% of the company’s international sales are medical
waste related. Prior to 2013, virtually all of the company’s international sales were medical waste
related.
Today, the domestic medical waste business generates ~40% EBITDA margin vs. ~16%
EBITDA margin for the International business. The margin differential is likely structural given
the persistency of the difference over time. The company has stated that it has a greater mix of
large accounts in its international business and offers less services that can be cross-sold.
In summary, the medical waste management business has historically been a strong business for
Stericycle. While I expect continued mid to high single digit growth from the segment, margin
compression driven by customer consolidation will hurt the business over time. The company’s
policy of prioritizing international growth will also lead to margin compression and declining
return on invested capital.
Stericycle’s Hazardous Waste Business Is Low Quality And Has Accounting Issues
Stericycle significantly expanded its hazardous waste management business when it acquired
PSC in April 2014 for $275 million. The company did not disclose the valuation paid. PSC
roughly doubled SRCL’s hazardous waste business and provided significant infrastructure which
could be used for additional growth.
Domestic vs. International Profitability
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Revenue
US $616 $721 $831 $913 $1,084 $1,212 $1,371 $1,498 $1,788 $2,165
International $173 $211 $253 $265 $356 $464 $542 $644 $767 $821
EBIT Margin
US 32.2% 30.5% 31.2% 32.2% 31.5% 32.3% N/A 32.8% 29.5% 22.8%
International 17.6% 17.4% 18.5% 21.0% 18.5% 17.5% N/A 15.3% 12.3% 8.7%
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Stericycle intended to use the company’s enhanced hazardous waste platform post-PSC to
accelerate growth through customer acquisitions. However, SRCL has had significant difficulty
integrating PSC. The biggest issue is accounting related. As a result of poor internal
organization, Stericycle received an adverse opinion from its auditor, Ernst & Young, for
having material weaknesses in its internal controls. The acquisition of PSC was specifically
called out as a key contributor to the material weakness.
Page 40 of Stericycle’s 2015 10K: “The Company’s risk assessment process did not operate
effectively, resulting in a material weakness pertaining to this component of the COSO
Framework. Specifically, the Company did not sufficiently identify risks associated with certain
routine processes and related information systems, including revenue, and certain non-routine
transactions. In addition, the Company did not properly design and implement appropriate
process-level internal controls at the Environmental Solutions component of the Domestic
Regulated and Compliance Services segment. The Environmental Solutions component primarily
consists of the PSC Environmental Services, LLC component acquired on April 22, 2014, which
was excluded from management assessment of internal controls over financial reporting as of
December 31, 2014. The material weakness relating to the risk assessment component of the
internal control framework contributed to the other material weaknesses described below.”
Separately, Stericycle’s auditor noted a weakness in the company’s ability to account for
revenue. This may result in the company restating some of its historical financials.
Page 41 of Stericycle’s 2015 10K: “Management concluded that there is a reasonable possibility
that a material misstatement could occur in the consolidated financial statements if the control
deficiencies were not remediated. Accordingly, management concluded that the matters
described above are material weaknesses in the Company’s internal control over financial
reporting and that the Company did not maintain effective internal control over financial
reporting as of December 31, 2015.”
As of the most recent quarter, the internal accounting issues still have not been fixed.
Page 24 of Stericycle’s 2016 Q1 10Q: “Although we have taken steps toward our planned
remediation of material weaknesses as described above, there were no changes implemented in
our internal control over financial reporting during the quarter ended March 31, 2016 that have
materially affected, or are reasonably likely to materially affect, our internal control over
financial reporting.”
The hazardous waste business is also structurally less profitable because the customer base
primarily consists of large accounts with better pricing power. Unlike its medical waste business,
Stericycle does not own any hazardous waste treatment facilities and must also pay for the waste
to be treated and disposed by third parties.
Finally, the hazardous waste business is cyclical because its customer base is primarily made up
of industrial companies. The energy and manufacturing downturn of the past 2 years has led to
lower volumes of hazardous waste to be picked up; Stericycle is paid by volume. Much of the
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softness in revenue which has led to earnings misses over the past year has been blamed on
lower hazardous waste volumes.
Stericycle’s Document Shredding Businesses Has Also Been Disappointing
In October 2015, Stericycle closed its $2.3 billion acquisition of Shred-it. Stericycle paid 9.3x
EBITDA and financed the transaction with $1.7 billion in debt and $700 million of convertible
preferred shares (convertible to shares representing ~5% of current outstanding). Shred-it is the
leading document destruction company and was set to IPO in Canada when SRCL acquired it.
This is Stericycle’s largest acquisition by a factor of 7x and is a totally new product category
for the company.
Source: Shred-it IPO prospectus.
The business model is similar to SRCL’s medical waste business. Customers deposit sensitive
documents in containers. Shred-it trucks pick up the containers and documents are destroyed at
processing facilities. Shred-it primarily serves small business accounts with multi-year contracts
and high customer retention rates. The business has benefited from increased regulations
regarding handling sensitive documents. Shred-is even has a similar acquisition-led growth
model. Great fit, right?
Where the Shred-it model differs is that 16% of revenue is generated from the re-sale of recycled
paper. Because margins on the pick-up and transport business are low, paper re-sale represents
~35% of the earnings mix. Although paper re-sale is highly profitable, it is also highly cyclical
and depends on the commodity price for recycled paper which fluctuates widely on
macroeconomic factors.
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Source: Shred-it IPO prospectus.
Another issue is that due to regulatory issues and current fleet constraints, the combined
company will still need to use different trucks for transporting medical waste and shredded paper
waste. There are limited cost synergies from the deal. Management is primarily betting on
revenue synergies from the ability to cross-sell additional services to existing/acquired
customers. Revenue synergies are very difficult to underwrite because they are much harder to
lock-in.
There is significant execution risk in the transaction because in addition to this being a new
business line for Stericycle, Shred-it was in the middle of a major merger with Cintas Document
Destruction when it was acquired. In 2014, Shred-it and Cintas merged in a transaction that
doubled the company’s size. When Stericycle acquired Shred-it, it paid a multiple based on
expected synergies from the Cintas merger that had not yet been materialized. Stericycle stated
that the management team carefully studied the expected synergies and expressed confidence in
realization.
Upon announcement of the Shred-it acquisition, management stated that there were $71 million
in synergies from the Shred-it/Cintas merger that were only 1/3 of the way done. Management
estimated that they could capture an addition $20 - $30 million in synergies from the
Stericycle/Shred-it deal. 9 Months later during the Q1 2016, management pushed back the
timeline on the realization of $20 million of the Cintas synergies to 2017/2018 and still has not
provided a timeline for the synergies between Stericycle and Shred-it. Remember, the Cintas
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deal closed in April 2014 and Stericycle assumed those synergies were a sure thing and paid up
for them. The unrealized synergies represented 22% of Shred-it’s Adj. EBITDA. Backing out
these unrealized synergies implies that Stericycle actually paid 12.0x EBITDA for the deal.
The delayed synergies involve re-routing trucks to improve efficiency and closing document
shredding facilities due to low utilization. Once these company-owned facilities are closed,
shred-it plans to use third-party shredding facilities. The incremental synergies from the
Stericycle/Shred-it deal will likely be focused on headcount reduction. These are all fairly
disruptive changes to the business and it is not a good sign that the timeline on these synergies
has been extended for another 2-3 years because they will likely hurt fundamental performance
of the Shred-it business until they are completed.
This acquisition has proven to be quite the mess. Despite M&A being a core competency and
competitive advantage of the company, Management’s recent acquisition track record is quite
poor when also considering the PSC deal. This is a troubling sign that the company’s
acquisition based business model has exhausted itself as the company needs to do larger deals
to maintain its expected growth rate but has proven unsuccessful in execution after large deals
have been made.
Recent Financial Performance
Over the last 2 years organic growth has slowed from 7% - 8% to 5% - 6%. During this same
period, the company made its acquisitions of PSC (Q2 2014) and Shred-it (Q4 2015) to boost
overall growth. Margins have also compressed as these new businesses are less profitable. EPS
growth has slowed and ROIC has also declined.
Stericycle has missed estimates in 3 of its last 5 earnings reports. On recent earnings calls the
company has blamed earnings misses on its hazardous waste segment failing to grow due to the
slowdown in energy and manufacturing. However, in Q1 2016, the company disclosed deeper
issues regarding the acquisition of Shred-it and has lowered earnings guidance. The stock market
Recent Financial Performance
Q1 2014 Q2 2014 Q3 2014 Q4 2014 Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016
Revenue $570 $641 $668 $677 $663 $716 $719 $888 $874
Total Growth % 10.9% 21.7% 24.9% 19.2% 16.4% 11.7% 7.6% 31.2% 31.8%
Organic Growth % 6.3% 7.2% 7.9% 8.0% 6.8% 7.7% 6.3% 5.2% 5.6%
Gross Profit $268 $290 $294 $298 $296 $319 $314 $399 $392
Margin % 47.1% 45.3% 44.0% 44.1% 44.6% 44.6% 43.7% 44.9% 44.8%
EBITDA $168 $181 $181 $187 $181 $196 $189 $220 $210
Margin % 29.5% 28.3% 27.0% 27.7% 27.2% 27.4% 26.3% 24.8% 24.1%
EBIT $145 $154 $152 $162 $153 $169 $162 $175 $162
Margin % 25.4% 24.0% 22.7% 24.0% 23.1% 23.6% 22.5% 19.7% 18.5%
Norml. Diluted EPS $0.92 $0.99 $0.98 $1.04 $0.96 $1.09 $1.03 $1.13 $0.99
Growth % 8.6% 12.3% 10.0% 18.3% 4.3% 10.2% 5.5% 9.0% 2.3%
Earnings Hit / Miss Hit Hit Hit Hit Miss Hit Miss Hit Miss
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has responded to the recent disappointments by punishing the stock from a high of ~$150 to the
current price of $104.7.
Source: Finviz.com as of July 8, 2016.
In Q3 2015, the company announced that it would change the way it calculates EPS to exclude
amortization. The company noted that amortization primarily results from non-recurring charges
associated with acquisitions and excluding amortization provides a more meaningful gauge on
earnings. Acquisitions are a core aspect of SRCL’s strategy. The company makes dozens of
acquisitions per year and the related charges associated with these acquisitions are constantly
recurring. This change in guidance is a red flag as it appears the company is aware that EPS
growth is declining and the company is trying to find a way to prop it up.
Valuation
Stericycle is not an easy company to value because the company does not have any good
publicly traded peers and the company does not provide segment financial detail. Significant
estimates and judgments are required, making the company’s valuation more on the art side of
the valuation continuum.
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Today Stericycle trades for 14.6x forward EBIT vs. a peer range of 15x – 20x. SRCL trades for
12.1x forward EBITDA vs. a peer range of 9x – 12x. The peer set isn’t great because SRCL is a
medical waste company which primarily transports and cleans waste before dropping it off at a
landfill. WM, RSG, and WCN are in the business of operating traditional waste management
businesses which include pick-up, transport, and landfill. CVA, CLH, ECOL, CWST, and HCCI
are more on the industrial / hazardous waste management side. Sharps Compliance (SMED) is
actually a medical waste management company similar to SRCL, but is a sub-scale business and
a microcap stock making it a less relevant comparison. Stericycle is generally less capital
intensive than the peer set which explains why the company looks more expensive on an
EBITDA basis vs. using an EBIT multiple.
Historically, the company has traded around 15x forward EIBTDA, making today’s 12x level
appear attractive. However, I would argue that Stericycle today is a lower quality company
because its growth prospects are lower and it has expanded into lower margin businesses.
Stericycle’s Historical Trading Multiples
Ideally a sum-of-the-parts (“SOTP”) approach is best because Stericycle’s businesses have such
diverse business profiles and profitability. However, the SOTP is limited because the actual sales
mix and margins are unknown. I have taken my best shot at making these estimates and applying
relevant valuation multiples. Note: the total sales and EBITDA figures tie out to consensus
analyst estimates for 2016E.
Relative Trading Value Analysis
Enterprise Market Dividend EV / EBIT EV / EBITDA LTM FCF NTM Sales '16 EBIT '16 EBIT LTM
Company Name Ticker Value Cap Yield % LTM NTM LTM NTM Yield % Growth % Growth % Margin % ROC % (1)
Waste Management WM $39,549 $30,037 2.3% 18.6x 16.6x 11.4x 10.8x 4.6% 2.9% 11.7% 17.6% 9.0%
Republic Services RSG $25,605 $18,075 2.2% 17.0x 16.0x 10.0x 9.5x 3.7% 3.0% 6.6% 16.9% 6.1%
Waste Connections WCN $14,943 $12,851 0.8% 34.2x 21.3x 21.0x 12.4x 2.5% 81.8% 60.7% 18.2% 6.5%
Covanta CVA $4,534 $2,157 6.0% 32.2x 30.8x 13.2x 11.0x N/A (0.8%) 4.4% 8.9% 2.9%
Clean Harbors CLH $4,316 $3,039 N/A 20.7x 23.1x 8.9x 9.1x 2.3% (10.6%) (10.7%) 6.6% 4.9%
US Ecology ECOL $1,298 $1,021 1.5% 16.1x 14.9x 10.6x 9.8x 4.1% (3.3%) 8.0% 16.6% 8.5%
Casella Waste Systems CWST $851 $338 N/A 26.5x 22.2x 8.9x 7.4x 6.7% 1.3% 19.5% 6.8% 4.0%
Heritage-Crystal Clean HCCI $328 $280 N/A 44.9x 22.8x 13.5x 9.6x 4.0% 1.5% 96.7% 4.1% 1.7%
Sharps Compliance SMED $77 $90 N/A 54.9x 25.5x 36.6x 18.1x N/A 17.8% 115.0% 7.6% 3.7%
Mean $10,167 $7,543 2.6% 29.4x 21.5x 14.9x 10.8x 4.0% 10.4% 34.6% 11.5% 5.3%
Median $4,316 $2,157 2.2% 26.5x 22.2x 11.4x 9.8x 4.0% 1.5% 11.7% 8.9% 4.9%
Stericycle SRCL $12,009 $8,890 N/A 18.0x 14.6x 14.7x 12.1x 3.2% 16.1% 22.9% 22.1% 8.8%
Source: Capital IQ, Wall Street consensus estimates. Data as of 7/8/2016.
(1) Return on Capital = Tax-effected EBIT / (Total Debt + Total Equity)
Median EV /
NTM EBIT NTM EBITDA
1 Yr 15.3x 12.7x
5 Yr 17.6x 15.2x
10 Yr 17.5x 15.2x
Source: Capital IQ. 10.0x
12.0x
14.0x
16.0x
18.0x
20.0x
22.0x
Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16
EV/ NTM EBIT EV/ NTM EBITDA
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The US medical waste multiple equates to a slight discount to Stericycle’s historical valuation
multiple where it was a pure-play medical waste company until 2010. The international waste
and Hazardous Waste businesses were estimated at 9.5x and 8.0x because they are primarily
large account oriented (low-margin) and are considerably sub-scale vs. the peer set. Arguably the
Hazardous business is worth far less due to its accounting issues; the company purchased PSC at
an ~8x multiple. The call center is valued at a premium to outsourced call center peers (CVG,
SYKE, TTEC). Shred-it is valued at roughly what SRCL paid for the business (less cash and tax
benefits). There are no good peers to the recall business so I gave it a 10x multiple because I
consider it be an average business (niche leader, high margins, unpredictable earnings).
The SOTP analysis indicates that Stericycle is valued at a slight premium to its implied value.
This strikes me as a very rich valuation given the accounting issues, execution uncertainties,
capital allocation mistakes, and headwinds in the core medical waste business. I believe
Stericycle should trade at a healthy discount to its implied fair value because earnings will be
under pressure and the valuation multiple could see continued compression as execution issues
come to light.
My first point of contention is the value of the US medical waste business which represents
~65% of the value of the whole company. I believe margins will fall over time as its customer
consolidate and renegotiate contracts. I also believe the valuation multiple should be lower than
it was historically because of lower growth prospects and the margin compression. Sensitizing
the potential impact of these adjustments to my SOTP analysis implied the overall company
could be worth 15% - 30% less.
Stericycle Sum of the Parts Valuation
Est. Sales Sales Mix Est. EBITDA % EBITDA EBITDA Mix EBITDA multiple Value
US Medical Waste $1,350 37.0% 40% $540 56.6% 14.0x $7,560
Intl. Medical Waste $615 16.9% 15% $92 9.7% 9.5x $876
Shred-it $750 20.6% 24% $180 18.9% 9.5x $1,710
Haz. Waste $630 17.3% 13% $82 8.6% 8.0x $655
Call Centers $200 5.5% 14% $28 2.9% 9.0x $252
Recall $100 2.7% 32% $32 3.4% 10.0x $320
Total $3,645 100.0% 26% $954 100.0% 11.9x $11,374
Net Debt $3,118
Implied Enterprise Value $8,255
Shares Outstanding 84.91
Implied Share Price $97.22
Current Share Price $104.70
Implied SOTP Discount (7.1%)
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Taking a bigger picture approach to estimating the value of Stericycle I have sensitized the
current forward EBITDA multiple vs. potential EBITDA declines resulting from the accounting
issues and execution problems. This implied as much as 40% - 50% downside if the earnings
picture gets worse and investors re-rate the stock lower. This may seem like a very arbitrary and
punitive analysis, but I believe there is a high probability of earnings being revised lower.
Remember the company has a material weakness in internal controls and revenue recognition
which could result in a significant restatement. The acquisition of Shred-it is a total mess. The
company has already revised 2016 EPS guidance lower by 5% - 10%.
Sentiment is still buoyant and could lead to downgrades and wider-spread pessimism on the
stock. Wall Street still has a lukewarm buy rating on the stock. Of 17 analysts which cover
Stericycle, 9 have buy ratings, 7 have hold ratings and there is 1 sell rating. Only 5.65% of
SRCL’s traded float is currently short.
Concluding Thoughts
Despite two decades of stellar financial results and stock price gains I believe the party is over
for Stericycle. The company’s formula of making bolt-on acquisitions in the medical waste
business has exhausted itself because several hundred acquisitions later there are far fewer
attractive targets. The company’s has proven itself a poor acquirer when striking larger
transformational deals. These issues coincide with Charles Alutto taking over as CEO and the
company has not signaled that it will make any changes to its current strategy. All of these
Implied Return Sensitivity
US Medical Waste EBITDA Multiple
14.0x 13.0x 12.0x 11.0x 10.0x
40.0% (7.1%) (13.2%) (19.3%) (25.4%) (31.4%)
39.0% (9.3%) (15.2%) (21.1%) (27.0%) (33.0%)
38.0% (11.4%) (17.2%) (22.9%) (28.7%) (34.5%)
37.0% (13.5%) (19.1%) (24.8%) (30.4%) (36.0%)
36.0% (15.6%) (21.1%) (26.6%) (32.0%) (37.5%)
35.0% (17.8%) (23.1%) (28.4%) (33.7%) (39.0%)
Note: Represents implied share return.
US
Med
ical W
aste
EB
ITD
A M
arg
in
Implied Return Sensitivity
Total Company EBITDA Multiple
14.0x 13.0x 12.0x 11.0x 10.0x
0.0% 15.2% 4.4% (6.3%) (17.0%) (27.8%)
(5.0%) 7.7% (2.5%) (12.7%) (22.9%) (33.1%)
(10.0%) 0.2% (9.5%) (19.2%) (28.8%) (38.5%)
(15.0%) (7.4%) (16.5%) (25.6%) (34.7%) (43.9%)
(20.0%) (14.9%) (23.5%) (32.0%) (40.6%) (49.2%)
(25.0%) (22.4%) (30.4%) (38.5%) (46.5%) (54.6%)
Note: Represents implied share return.
EB
ITD
A Im
pact
of
execu
tio
n issu
es
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problems have compounded on each other and have developed a negative “lollapalooza effect”.
Given that most of the issues are unresolved, I believe the situation at Stericycle will likely get
worse before it gets better.