Description

At 29x P/E and 19x EV/TTM EBITDA, PESI does not screen well for value on a trailing basis. Perma-Fix’s 2020 earnings would have been much higher given the substantial growth and sustainable profitability in its Services Segment were it not for the temporary underperformance in its Treatment Segment caused by the pandemic. Note that demand for the Treatment Segment’s offerings didn’t disappear, toxic nuclear waste must be treated before disposal in accordance with health and environmental regulations. This work will recover to pre-pandemic levels at some point, management believes as early as this summer. Thus the core of this investment thesis is that beginning in late 2021 we’ll start to see a step-function change in Perma-Fix’s earnings thanks to 1) a recovery in the Treatment Segment and 2) continued growth in the Services Segment.

Based on conservative inputs we estimate that PESI trades at a 7-9x EV/normalized EBITDA multiple. This is a bargain price to pay for a business that’s growing profitably, enjoys high barriers to entry and has a nearly debt-free balance sheet. On the upside, there’s a windfall opportunity the company is pursuing in Hanford, WA at the largest nuclear waste site in the US. Perma-Fix has already begun demonstrating the viability of its treatment solution to regulators, and is the only company to have successfully treated nuclear waste from Hanford. The timeline for contract award is uncertain and may take years, but there’s a renewed sense of urgency here as just last week they detected a new toxic leak at the site. 

Business Overview

For over 25 years Perma-Fix has provided nuclear and industrial services to government clients including the Department of Energy and the Department of Defense, as well as commercial enterprises involved in mining and metals, oil and gas, nuclear power, medical and industrial waste markets. Over decades the company has developed proprietary IP related to chemical treatment processes and technologies related to nuclear waste treatment. Stringent regulations and permit requirements provide Perma-Fix’s waste-related business with a significant barrier to entry.

Investment Thesis: Perma-Fix’s True “Earnings Power” Is Better Than Recent Earnings Suggest

Perma-Fix reports results for two business segments – a Treatment Segment and a Services Segment.

The Treatment Segment provides hazardous and non-hazardous waste treatment, processing, and disposal services through several treatment facilities. Historically, this segment has generated stable sales levels of $9-10M quarterly and gross margins ranging between 20-30%. The primary expense incurred to treat waste comes from the fixed cost of running the facilities, meaning that as waste treatment volumes grow, incremental sales dollars lead to gross margin expansion (aka operating leverage). When waste treatment volumes decline however, the fixed cost base ensures that gross profits can dry up quickly. This is what happened in 2020. When the pandemic started, generators were temporarily shut down and many of Perma-Fix’s clients had difficulty transporting toxic waste for treatment. These headwinds persisted through most of 2020, resulting in pre-tax income of $1.5M, a significant decline from the $8.0M and $4.6M reported in 2019 and 2018 respectively. Management has indicated that they’re beginning to see waste shipments and notices of shipments increase in the last month. They’re now estimating a sales recovery to their $9-$10M quarterly sales cadence as soon as June, but most likely by the end of 2021. Again, toxic nuclear waste must be treated and processed in order to be disposed of as a matter of environmental safety and health regulations, thus demand for waste treatment doesn’t disappear but it can be deferred. In the meantime, the company has been upgrading their treatment facilities to expand the waste types they’re capable of treating, setting the stage for a strong 2022. 

The Services Segment performs radiological measurements, health physics services, industrial hygiene assessments, and other technical services related to waste management. The cost structure is variable and scales with the level of work. It has historically generated gross profit margins in the range of 10% to 14%. Over the last few years management has focused on building their bidding team to aggressively pursue service contracts and has expanded the scope of their bidding into international and commercial areas to diversify beyond their government focus. As a result the Service Segment’s top-line has grown at a rate of >100% YoY for the last two years in a row and continues to gain market share. In 2020 this segment overtook the Treatment Segment in both sales dollars and earnings despite the pandemic headwinds. In doing so, the Service Segment has achieved a scale at which its profits are very meaningful to PESI’s bottom line, generating pre-tax income of $7.8M in 2020, up significantly from $0.8M and $(0.8M) reported in 2019 and 2018 respectively. Management recently disclosed that they’re seeing an unprecedented amount of bidding activity on the service side of the business. Between the DOE and other customers, Perma-Fix is bidding on contracts totaling several hundred million dollars per year in value, yet another indication that 2022 is going to be a strong year.

Once waste streams normalize in 2021 there will be not one, but two segments generating material earnings. These earnings will be shielded from taxability to a certain point thanks to Perma-Fix’s accumulated net operating loss carryforwards of ~$14M and ~$71M for federal and state income tax purposes respectively.

Valuation and Share Price Upside

Perma-Fix trades at ~19x EV/EBITDA based on FY 2020 when the Treatment Segment’s EBITDA temporarily declined ~70% YoY. Had the Treatment Segment remained in line with 2019 and 2018, consolidated EBITDA would have been more than double what was reported in 2020, the EV/EBITDA multiple would be closer to 7-9x at today’s price. This is a bargain valuation for a business that’s growing profitably with high barriers to entry (in a market at record highs nonetheless).

Using what we believe to be reasonable assumptions we’ll illustrate what the potential upside profile looks like. In a scenario where the Treatment Segment recovers to historical run-rate of $10M sales per month and the Service Segment grows sales at a reduced growth rate of 50%, PESI would report annual sales of ~$153M and generate about $14M in EBITDA (roughly a 9% margin). At a conservative 10x EV/EBITDA multiple this would imply a share price of ~$11 per share, generating a return of ~45% over PESI’s last closing price. In a more optimistic scenario where the treatment business recovers to historical levels and the services segment continues to grow 100% YoY, sales could reach ~$191M and produce $19M in EBITDA (~10% margin). Keeping our assumed 10x EV/EBITDA would imply a share price of ~$15 per share, a return of ~100% over the last closing share price.

Margin of Safety/Downside Protection: The replacement value of Perma-Fix’s asset base in relation to its market cap gives some assurance that long-term owners won’t lose too much. PESI owns three treatment facilities (Richland, WA facility sits on 35 acres of land; Gainesville, FL facility sits on estimated five acres of land; Kingston, TN facility sits on estimated one acre of land), specialized treatment equipment, a highly specialized labor force, permits that require years and significant cost to obtain, IP related to its proprietary chemistry and treatment capabilities, and net cash and equivalents of $6.4M (plus another $11.4M of cash not reflected on balance sheet as discussed below). For ~$90M we get these assets plus a growing, cash flowing business.

The balance sheet is strong with $7.9M in cash and a debt balance of $6.8M. However, $5.3M of the debt balance is related to a forgivable PPP loan, so the balance of debt that has to be repaid is just the $1.5M related to its term loan. There’s an additional source of liquidity in PESI’s $11.4M in cash held as collateral under a financial assurance policy with AIG, which provides coverage of up to ~$28M for the company’s facilities in the event of unforeseen closure. If Perma-Fix elects to do so, AIG is obligated to repay this restricted cash balance in return for complete release of liability. Suffice it to say Perma-Fix’s balance sheet is rock solid.

Upside Optionality: Hanford Nuclear Site

This is not a core part of the undervaluation of PESI’s business as it stands today, rather a longer term call option that could push the stock up by many multiples if things play out as expected. It’s a complex situation and deserves its own writeup, but I’ll do my best to summarize the situation and am happy to address it in more detail in the discussion section.

The Hanford site is a 580 square mile region in Washington where majority of the nuclear material created for the nation’s nuclear weapons program during the cold war was produced. Today it is a decommissioned nuclear facility and the site of 56 million gallons of nuclear waste stored across 177 underground tanks.  In 1989, the Department of Energy (DOE), the Environmental Protection Agency, and the State of Washington Department of Ecology entered into a cleanup agreement (known as the Tri-Party Agreement) that outlined a plan for clean-up of the site. In 2010, regulators established a plan to begin building an on-site treatment facility (the “Vitrification Plant”). Recent estimates suggest that cleaning up Hanford will take decades to complete and cost between $323B and $677B.

As way of background, there are two different treatment solutions being considered for Hanford’s nuclear waste:

1. Vitrification: transforming the waste into a glass and then placing it in a canister
2. Grouting: mixing the waste into a concrete-like substance

The key factor in deciding between vitrification and grouting comes down to how to classify the waste at Hanford. Waste classified as low-level waste (LLW) is commonly treated via grouting, whereas high level waste (HLW) requires vitrification due to its higher radioactivity. Today, about 58% of Hanford’s waste is classified as HLW and 42% of it as LLW. The Vitrification Plant was designed to vitrify all HLW and about 40% of the LLW. Regulators have yet to decide on a treatment alternative for the remaining 60% of LLW at Hanford. This is where Perma-Fix comes into the situation. In 2016 the DOE commissioned the “Test-Bed Initiative” (TBI) to begin exploring a way to demonstrate grouting as a treatment solution for Hanford’s LLW. The TBI included Perma-Fix as the commercial partner to grout waste from Hanford in three staged phases. In 2017 Perma-Fix successfully grouted 3 gallons of LLW completing Phase I of the TBI. After some delay (which wasn’t Perma-Fix’s fault), Perma-Fix is now scheduled to grout another 2,000 gallons of LLW for Phase II in 2021, for which Congress has approved $10M in funding. Finally, they will have to grout a 100,000 gallon batch for phase III to successfully complete the TBI.

With potentially millions of gallons to grout at Hanford, this represents a windfall sales opportunity for Perma-Fix. Unfortunately it’s impossible to know when meaningful work will begin at Hanford due to politics and advocacy groups pushing for different solutions. What we do know is that there’s tremendous local and federal support for Perma-Fix to begin treating Hanford’s waste as soon as possible. The newly appointed head of the DOE under the Biden administration has called out Hanford as an urgent task and has publicly committed to increasing funding to expedite work. The Vitrification Plant was supposed to begin treating a portion of the waste by 2023 and to reach full treatment capabilities by 2036. However, the construction of this plant has been continually delayed, hindered by technical issues, cost over-runs and fraud. The US Army Corp of Engineers has reported that these deadlines for the Vitrification Plant are not likely to be met given current conditions and funding levels. The DOE submitted a report to Congress in December 2020 calling for grouting to be used on a larger percentage of Hanford’s waste, given that much of what was initially considered HLW when it was placed into tanks decades ago has turned into LLW as of today. In fact, international standards commonly make the distinction between HLW vs. LLW based on current radiological characteristics, it’s just at Hanford where they’ve classified LLW as HLW because it was HLW when it was put into tanks and thus retains that classification per legal agreements. The same DOE report suggests that reclassifying and grouting the mis-classified LLW will save over $200 billion for tax payers, cut 10 years off the treatment timeline, and allow for disposal in an environmentally friendly manner. If reclassification does occur, it will enhance the sales prospects for Perma-Fix by a substantial degree.

The situation at Hanford is truly urgent and delays only increase the risk of tank leakage and environmental contamination. In fact a new tank leak was detected on April 29, 2021. This should put even greater pressure on regulators to act. Absent any major changes Perma-Fix is positioned to treat excess LLW at Hanford, however the uncertainty in timing and magnitude of the opportunity makes modeling an impractical exercise. The only reasonable conclusion is that if Perma-Fix wins the treatment work at Hanford, shares will re-rate significantly higher.

Insiders Aligned with Shareholders

Insiders own roughly 8% of the stock and several insiders have been consistent open market buyers of the shares throughout 2020 and into 2021.

Catalysts

-        Return of full waste treatment volumes, expected before year-end 2021

-        Continued growth in Services Segment, which has grown >100% over the last two years and is now seeing unprecedented levels of bidding activity

-        Progress toward Hanford site cleanup work

Risks to this thesis

-       Price volatility associated with being a thinly traded, under-followed small cap stock

-       Politics may delay work at the Hanford site, but the core thesis doesn’t rely on the Hanford opportunity given how cheap the stock is

-     Perma-Fix reports Q1 earnings this week, I have no reason to be optimistic for this quarter’s earnings so there may very well be a negative reaction by the market. On the positive side, as long as there are no major impacts to this thesis, a price decline may be a buying opportunity.

Catalyst

Listed Above