Just a generation ago, our collective attitude to hazardous waste might have been described as lackadaisical, at best. Syringes, bio-wastes and other waste products from the health care system often went into regular waste streams with little concern.
Since then, however, that collective attitude has turned to vigilant, even hyper-vigilance sometime. We no longer accept anything but the utmost of care when managing and disposing of those wastes. It’s been sea change, and one that’s been driven by public awareness, legislation, and litigation.
One company that made the most of this new attitude is Stericycle, Inc. (SRCL, Financial), a 1989 startup that has grown into a $2 billion-plus corporation.
Here’s a quick look at its price (green line) and earnings (blue line) over the past 25 years:
Stericycle belongs to a small, elite group of companies; it is one of only six that made it through three different screeners at GuruFocus: Undervalued Predictable, Buffet Munger, and Low P/S. Vera Yuan explains in her article, How Many Stocks Can Pass GuruFocus Value Screeners? - September 2, 2014.
With that, let’s take a closer look at the company and some of the metrics that lie behind the rankings.
About Stericycle
History
- 1988: U.S. Congress passes the Medical Waste Tracking Act
- 1989: Stericycle founded with the intent of addressing confusion over the new legislation, and focused originally on hospital waste
- 1996: begins trading on NASDAQ, symbol SRCL
- 1996: acquires the medical waste business of Waste Management Inc.
- 1998: first international operations, in Mexico and Brazil; subsequently expands into nine other countries
- 1999: begins offering safety and compliance training services with Stericycle Steri-Safe
- 2003: acquires Bio Systems and introduces Sharps Management Service
- 2003: enters the reverse distribution industry via acquisition of DirectRETURN
- 2010: introduces ExpertSUSTAINABILITY division to manage excess inventory and unsalable items
- 2010: acquires three large communication companies and expands into Healthcare Communication Solutions and Commercial Communication Solutions
- 2014: acquires PSC Environmental Services LLC and expands its coverage of hazardous waste management
- Since 1993 it has made 353 "successful" acquisitions, according to a Q1-2014 Investor Presentation
Takeaways: A young company, and one that has grown exponentially through strategic acquisitions. In addition to its U.S. operations, it has expanded into other countries (unless otherwise noted, history based on information provided at the company website and Wikipedia.org).
The business model
As noted, the company specializes in health and hazardous wastes. It describes itself on its website as "Our primary business comprises disposal services for medical and biohazardous waste. We serve hospitals, laboratories, physician practices, dental clinics, long-term care facilities, as well as numerous other businesses, facilities, and healthcare providers that generate sharps or potentially infectious material."
In addition, "Globally, we operate medical waste services in the United States, United Kingdom, Ireland, Canada, Mexico, Brazil, Argentina, Chile, Romania, Spain, and Portugal."
And "... specialized waste disposal services to healthcare facilities and other businesses, such as: Pharmaceutical Waste Disposal, Hazardous Waste Management, and Sustainability Services" (source: company website)
Reporting segments: United States and International. As the following excerpt from the 10-K Report for 2013 shows, about 70% of that year’s revenue came from American operations and about 30% from international operations:
Competition
In its 10-K report, the company describes its industry as highly competitive, with very low barriers to entry. In addition, it faces competition from large waste generators (big hospitals, for example) that handle their own output, and from potentially disruptive technologies and products.
At the same time, it says in a Q1, 2014 investor presentation it says it enjoys several advantages:
- Insulation from economic cycles
- 95% of revenues under long-term contracts, for predictable revenue
- Most contracts provide pass-through price increase provisions
In that same presentation, Stericycle says it holds about a 15% market share of this $15.5-billion market:
Takeaways: While operating many different services and countries, SRCL does maintain its focus on regulated wastes and ancillary services. And it has structured its business to give it continuity and protection from increasing costs.
Growth strategy
A continuing focus on "... small-quantity generators of regulated waste such as doctors’ offices, dentists, retailers or other commercial businesses" which makes up 62% of its current revenue (38% from large quantity generators).
In its Investor Presentation, Stericycle says small-quantity customers offer several advantages, including higher gross margins, being more likely to outsource hazardous waste management and are easier to upsell. Sales to small-quantity prospects are through telemarketing and direct marketing (large-quantity prospects and customers are handled by account executives and various specialists).
In addition, we would expect the company to continue its ambitious acquisitions plan. Its criteria for acquisitions are described this way in the Investor Presentation, "Purchase price is based on IRR/multiples of EBITDA and depends on the risk and quality of the assets purchased"
Takeaways: Stericycle does not provide comparative costs for customer acquisitions, that is, how much it needs to spend to acquire a dollar’s worth of revenue from small- vs. large-quantity generators. However, it does tells us that it can earn higher gross margins from small-quantity customers.
Management
President and CEO: Charles A. Alutto has held the position since January 2013; joined the company in 1997 as the result of an acquisition
Executive Chairman: Mark C. Miller became CEO in 1992 and Chairman of the Board of Directors in 2008; before joining Stericycle he held several management positions at Abbott Laboratories
Executive Vice President and Chief Financial Officer: Daniel V. Ginnetti became CFO in August 2014; joined the company in 2003 after serving in several financial management positions at an engineering company
A board of 9 members, including Mr. Alutto and Mr. Miller; directorial experience includes health care, capital investment, private equity, manufacturing and distribution, technology, and international business. At least four of the directors list some connection with Abbott Laboratories.
Stericycle receives a rating of 3/10 from the ISS Governance QuickScore Summary; on this scale, a rating of 1 is very good and a rating of 10 is very poor, so SRCL receives a good rating. It receives two red flags, one for Pay for Performance and one for Equity Risk Mitigation
Takeaways: A set of executives with long-standing connections to the company; and as might be expected with a company that has made more than 350 acquisitions, its board has good range and depth of financing expertise.
Ownership
Eight gurus followed by GuruFocus own shares in Stericycle; the biggest holder among them is David Rolfe (Trades, Portfolio) with almost 2,400,000 shares. Jim Simons owns almost 600,000 and Meridian Funds (Trades, Portfolio) almost 500,000.
Institutional Investors: According to Yahoo! Finance, 92% of shares belong to institutional investors and mutual funds; largest among them is Vanguard Group with just under 6-million shares.
Short Interests: Currently at 2.5%, a low proportion; the following chart shows the history of short interests:
Insiders: GuruFocus puts insider ownership at 2%, and Yahoo! Finance reports that director Jack Schuler is the biggest holder at 700,649 shares. Executive Chairman and former CEO Mark Miller holds 231,206 shares (share holdings as of December 31, 2014)
Takeaways: Stericycle enjoys the confidence of big money investors, institutional investors. This suggests a solid company that enjoys good expectations, but large institutional holdings also suggest we should not expect dramatic increases in share prices.
SRCL by the Numbers
Financial strength
The GuruFocus algorithms give Stericycle an 8/10 for Financial Strength and 8/10 for Profitability and Growth:
Over the five fiscal years ending in December 2013, SRCL’s Debt to Equity Ratio has moved down from 1.17 (2009) to .82 (2013). In dollar terms, it has gone from $911-million in 2009 to $1,268-million in 2013 (the absolute dollar number is up, but in relation to equity is lower).
The company boasts an operating ratio of 23.71, higher than 94% of the 183 companies in the waste management industry. The following chart shows its relatively consistent margins over the past decade and a half, and how it compares with the industry (blue line):
Its EBITDA growth also shows consistency and strength:
Takeaways: By all standard metrics, Stericycle is doing well: debt is down when measured by Debt/Equity, it has strong operating margins, and ETBITDA has grown consistently.
Valuations
As noted in the introduction to this article, Stericycle was one of six companies to make it through three separate screens at the GuruFocus website:
- Undervalued Predictable
- Buffet Munger, and
- Low P/S
Undervalued Predictable screens look for stocks priced below their Discount Cash Flow value and delivering consistent earnings. SRCL has a Discount Cash Flow value of $126.00, which is $10.75, or 8.5% above its closing price of $115.25 on September 26. It enjoys a 5-Star predictability rating, the highest rating available. According to GuruFocus backtesting, companies with a 5-Star rating average gains of 12.1% a year, and only 3% are expected to be in a loss position if held for 10 years.
We also note that the Discount Cash Flow value of $126 is only about half a dollar away from the stock's 52-week high of $125.43.
Buffett Munger screens look for good companies at fair or undervalued prices. Buffett refers, of course, to legendary investing guru Warren Buffett (Trades, Portfolio) of Berkshire Hathaway, and his associate/partner, Charlie Munger (Trades, Portfolio) (officially, Vice Chairman of Berkshire Hathaway). The screen produces firms with highly predictable earnings, a distinct competitive advantage ("moat"), growth without taking on too much debt, and share prices at or below fair value. To calculate the latter, the screen uses PEPG. That’s the P/E ratio divided by the average growth rate of EBITDA over the past 5 years.
Since Ms. Yuan’s article was written on September 2, SRCL has come off the Buffett Munger screen, but we can still calculate PEPG. Checking the Financials page at GuruFocus we see the five-year EBITDA rate is 14.7% and the P/E (ttm) ratio is 31.30. Dividing the latter by the former (31.30/14.7), we get PEPG of 2.13. Fair value is defined as 1.0 to 2.0 so Stericycle just misses the cut; while we don’t expect any quick changes to the EBITDA part of the equation, we can reasonably expect the stock price to fluctuate, thus changing the P/E, and ultimately the PEPG.
Low P/S screens help answer that age-old investing question: Is the company cheap or expensive compared to where it was last week/quarter/year? The following chart puts the price (based on its history) of SRCL into context (green line for P/S and blue line for the Waste Management industry):
Over the past 10 years, the P/S has fluctuated between 3.63 and 5.97. Currently, it comes in at 4.32 and looks relatively low when compared with where it’s been over the past few years. That’s enough to qualify it as a Historically Low P/S stock.
For a valuation on P/S terms, we’ll look at the Median P/S Value score. GuruFocus provides this value, and the methodology, when we click on P/S in the Valuation area of the Summary page (you’ll also see a couple of icons indicating how the stock compares with its industry and with its own history). SRCL receives a Median P/S valuation of $118.95 and a ratio reading of 0.97. That is, the current price of $115.25 represents 97% of $118.95. Or to put it as simply as possible, the stock is slightly undervalued on this metric.
It’s also worth looking at the Median P/S ratio over time, with its sure and steady growth:
Takeaways: SRCL has relatively high P/E ratios (31.3 trailing and 24.2 forward), but based on the Discount Cash Flow and Median P/S values provided, we conclude that Stericycle is fairly or slightly undervalued by the market.
Opportunities and risks
Stericycle has a 15% market share, with 569,000 customers (both large- and small-quantity companies) and what it calls a ‘loyal customer base’ (Investor Presentation)
95% of its revenues come from long-term contracts, and contracts generally allow the company to pass along its new costs to customers
An aging population means more more demand for medical services, and more regulated or medical waste
Expertise and experience in acquisitions, which will allow it to grow faster than it would if it depended solely on organic growth
While barriers to entry into the industry are nominally low, the industry is highly regulated so many existing competitors and new entrants will face expertise and funding hurdles if they try to take market share
Turning to risks, the company says it faces extensive government regulations, and these regulations may be "... frequently difficult, expensive and time consuming to comply with."
The future level of regulatory enforcement adds uncertainty to operations and results
Because of its acquisitions profile, the company may be subject to antitrust issues
Further expansion into other countries could expose it to foreseeable (currency fluctuations) and unforeseeable problems
The handling of hazardous wastes exposes its employees to dangerous situations and the company to environmental liabilities (opportunities and risks based on information provided in the company’s Investor Presentation and 10-K Report for 2013)
Outlook
Considering the information and data we’ve seen, Stericycle seems to be in good shape and poised to keep growing. While potential risks exist, many are now being met successfully in day-to-day operations, and the company does have many resources to meet future challenges.
Conclusions
Stericycle passed through three GuruFocus screens at the beginning of September. It has since dropped from the Buffett Munger Screen, but it remains very close to the fair value cutoff. Of course, qualifying with two screeners is no small feat and should be recognized.
Taken together, all signs point to a solid company with excellent prospects. The two key valuations we reviewed suggest a fairly or slightly undervalued company, and its earnings have been more predictable than those of most other companies in the industry.
The company does not pay a dividend and does not intend to pay one. Instead it uses cash flow and/or retained earnings to make acquisitions and buy back shares (about equally, in fiscal 2013).
Investors looking for potential capital gains should give SRCL a close or closer look.
