Description

 In this recession you can not find many companies that are going to almost double revenues and margins in a span of 2 years and keep growing from there, but PESI is one of them.   While PESI does not look cheap on the surface, it is a company undergoing several transformational events.  The company has sold its underperforming assets, which were a drag on earnings and made reported results confusing, and it has won several new contracts and permits, which have jumpstarted its top line and will boost margins.

PESI is an environmental remediation services company, focusing on nuclear waste management, which represents 81% of its revenue.  It also operates engineering consulting and industrial waste management services subsidiaries. 

Its main nuclear waste facilities are Perma-Fix of Florida (PFF), Diversified Scientific Services, Inc (DSSI), East Tennessee Materials & Energy Corp (M&EC), and Perma-Fix Northwest Richland (PFNWR).  PFF specializes in the storage, processing, and treatment of certain types of waste, including low level radioactive and hazardous waste.  DSSI is located in Kingston, TN, and is similar to PFF, but it also handles liquid organic mixed waste and was just awarded a PCB permit.  M&EC is located in Oak Ridge, TN and is the largest PESI facility, operating under a hazardous waste permit and a radioactive materials license.  It also recently was awarded a significant subcontractor role in the Hanford, WA cleanup (more on Hanford later).  PFNWR was acquired in 6/07 and is adjacent to the Hanford, WA site and treats hazardous, low level waste and mixed waste. 

The basic business model is to acquire permits from the government to treat waste from remediation sites.  Management has been narrowing its focus to treat waste that few others can, or that no one else can, or that the government no longer wants to treat.  Government contractors amass the waste on site as the cleanup happens and then ship to PESI for treatment.  After PESI treats the waste it is sent to a government or commercial landfill for disposal.  PESI some has some discretion over what waste it receives at certain times, so earlier in its contract it usually treats the higher margin waste.  Shipments to PESI can be erratic and PESI will often let waste build up at its facilities, so that it can get better utilization when the treatment is done, so both revenues and margins can be volatile.  The federal government is responsible for the vast majority of revenues.

There are a number of interesting catalysts because PESI has just achieved several milestones that will dramatically improve results.  First and foremost, through M&EC PESI was awarded a subcontract n 6/09 by the DOE's general contractor, CH Plateau Remediation Company (CHPRC) to treat waste in Hanford, WA, which is the largest environmental clean up in the world.  Nuclear waste has been stored there since the Manhattan project.  The contract became effective 10/1/09 is for five years.  This contract is a substantial growth driver and could generate more than $30 million annually in revenue.  In addition to the treatment of waste, this contract involves on site management of the remediation.  This is PESI's first significant foray into this area and is important because it is another large revenue stream, but also because it allows PESI to have more control on what waste is sent where, which is important since PESI has PFNWR next door to the project, which could provide upside to the contract.  In its first quarter this contract had a meaningful impact on PESI's results and should contribute even more in the upcoming quarters.

In 11/08 the EPA awarded PESI a commercial permit to treat radioactive PCB's at DSSI, which has been in the process for years.  There no other commercial facilities to treat this type of waste and there are no other companies even in the process of trying to gain permitting.  The only other facility that does treat this waste is run by the DOE in TN that is next to DSSI.  This DOE facility will be shutting down in 5/09 as a result of PESI acquiring this permit.  The volume of waste that flows through the DOE facility alone would generate about $15 million of revenue, although there will obviously be a transition period that could take several quarters.  Commercial utilities also represent a large potential end market.  Up until now, commercial utilities have had no outlet for this type of PCB waste, which PESI can now treat.  The DOE and EPA have looked the other way on this waste because there were really no solutions for utilities, but now there is and management believes there is considerable pent up demand, although it will take some time for utilities to proceed.  PESI is just starting to receive shipments of radioactive PCB's.

The DOE budget is dramatically improved in 2009.  During the last years of the Bush administration DOE budgets and appropriations were cut.  This meant that contractors were sending less waste to PESI lowering volumes and utilization.  The DOE budget is increasing this year from $5.2 to $6.4 billion.  In addition to the regular budget growing, an additional $6.6 billion has been allocated to DOE remediation projects in the stimulus bill.  Clearly, these are huge numbers and it is nearly impossible to know how it will really be spent and much smaller numbers will filter down to PESI, but it still a big positive. 

PESI also has a couple of other avenues for growth.  There are many smaller private companies that are site specific.  PESI thinks that in the coming years there will be some interesting acquisition opportunities now that they do not have to compete with private equity.  PESI is not doing any acquisitions though, until CHPRC and PCB's are up and running, and consequently, cash flows and the balance sheet have improved.  The other opportunity is in onsite management.  Hanford is the first big contract for PESI in this field, but management thinks that there are a lot of other opportunities to expand in this area.  This type of business can be very additive to the top line, but is lower gross margin, since it is all cost plus contracts, but this also means that most of gross profit drops to the bottom line, making net income comparable.

The past several years have been messy for PESI.  A number of factors have contributed to weak and confusing results, which has made it misunderstood and an undervalued story.  In addition to the DOE being underfunded as discussed above, PESI has been undergoing a transformational restructuring.  PESI for the most part exited its unprofitable, commoditized industrial waste businesses, and is focusing on the high ROIC nuclear waste business.

Management decided to divest the industrial waste management subsidiaries in 5/07.  The initial deal to sell the entire division fell apart and management then decided to pursue sales of each facility in a piecemeal fashion.  All of the underperforming facilities were sold and as the credit markets dried up and bids were harder to come by, they decided to retain the three remaining industrial waste management facilities, Perma-fix of Fort Lauderdale, Perma-Fix of South Georgia, and Perma-fix of Orlando.  The industrial business had been reported as discontinued operations since the decision to divest them was made, so when management decided to keep these facilities they were brought back into reported results in 9/08, which has made reporting somewhat confusing.  All of the remaining facilities are cash flow positive and self sustaining, so they should not be a drag on earnings as the facilities that were sold were.  These facilities should generate about $1million of EBITDA. 

The remaining nuclear waste business is a good business because the permits create barriers to entry and there is very little competition in PESI's core business, which means pricing is relatively stable for any given type of waste.  ES is the closest competitor, but it has a much broader business model and treats lower level waste for the most part.   Also, PESI very low capital requirements and significant excess capacity, so additional streams of waste can be treated at almost no extra cost, so the incremental margins are very high.

Guidance for 2009 is for greater than $100 million in revenue and EBITDA margins of 10-15%, depending on the timing of the roll out of government contracts.  In 2010 I think PESI could generate about $20 million of EBITDA as revenue and margins continue to improve.  This still does not make it seem like the cheapest stock out there, but I think these estimates are conservative, even though they imply some pretty high growth rates, because there are just so many good things happening in its end markets right now.  Furthermore, there should be an extremely high conversion of EBITDA into free cash flow, as capex should continue to be lower than depreciation, debt will be paid down, and there are $27 million of NOL's.  I think that the change from the restructuring and in the outlook has not been fully reflected in the valuation.

Insiders only own about 5.5% of the company, but they have been buying in the open market over the past few months.  CEO, Lou Centofanti, personally owns 920,000 shares.  He is 62 and is looking for an exit strategy, although he is looking to capitalize on a lot of these catalysts before he retires. 

The main risk I see is that the balance sheet is not great.  It has not been great for a while and management is accustomed to operating on a shoestring, which I like, but at the same time it does not leave them much margin for error, but in the past creditors have been very flexible with PESI in amending covenants.  As a result of the state of the balance sheet and the credit markets, management decided to file a shelf of 5 million shares, which could act as an overhang and potentially come to market.  They did this in case they were tight on working capital as these various projects ramp, while they have about $5 million of debt payments in 2009. Hopefully, we will not see these shares come to market, but it is possible in the June time frame, if they can not finance these payments another way.  Other risks include: shipments are lumpy, which means revenue can be lumpy, and this business has the potential for environment liabilities. 

Catalyst

Hanford contract

PCB permit