Description

Secure (ticker: SES CN) - LONG

Current Price: $8.79

Price Target (2-year time horizon): $19 (125% return: 115% price + 5% div for 2 years)

Mkt Cap $2.6b / Enterprise Value $3.6b

Thesis Summary

This is a timely idea because it was just de-risked with the announced asset sale last week. Secure is a high-quality company trading at a depressed valuation with three major positive developments. The first is the ongoing transformation from an energy service company to a waste management/infrastructure company.  The second development is the pending sale of assets at an accretive valuation.  Secure was ordered to sell a portion of the Tervita acquired assets by the regulatory Tribunal in Canada.  They just announced on 12/11/23 that they are selling these assets for $1.15b, which is 45% of the market cap. and will lead to a substantial buyback.  The divestiture will both confirm the value of the remaining assets and lead to a re-rating in the stock.  The cherry on top is that mgmt. set ’24 earnings expectations low, so there is substantial upside to earnings.  The Street assumes $0.63 eps in ‘25 and I am at $1.20.  I expect the stock to double in 2 years with the majority of the move happening within 6 months.   

Description and Background

Secure owns 17 landfills, 73 waste processing facilities, 5 metal recycling facilities, 23 oil terminals, and 3 pipelines.  Assets are mostly in Canada and HQ is Calgary.  They operate 2 segments: Environmental Waste Management which is 70% of ebitda and Energy Infrastructure which is 30%.  Customers are from the energy, industrial and mining sectors. 

Transformation

Secure has been in the process of transforming from an energy service company to an infrastructure and waste management company.   This is important for a few reasons.  First, these are more stable businesses with recurring revenue and free cash flow.  Second, they are less vulnerable to the whims of energy prices. Third, they are difficult to replicate either because they require hard-to-get permits (i.e. for landfills) or large upfront investments to process waste.  Fourth, they deserve and trade at significantly higher valuations.

It is difficult to extrapolate Secure’s historical track record because of the changes that have taken place over the past decade.  In 2014, recurring revenue was only 40% of the business and today it is 90%.  Secure has improved its mix through acquisitions as well as signing new business with take-or-pay contracts of up to 12-years in duration.  

Management has started benchmarking themselves against the leaders in the waste management space.  The table below from their investor deck illustrates that Secure stacks up well in terms of key metrics. 

This is clearly a high-quality business with 37% ebitda margins.  Part of the reason for this is that waste removal is regulated and there are few competitors where Secure operates -- which is the reason in the first place they are being forced to divest assets.  Also, this is a growth business based on production, and the CEO believes they can grow organically 5% per year.

Despite leading in most benchmarked categories, Secure trades at a significant valuation discount.  Waste peers trade at 25x ’25 earnings and 12x ebitda, whereas SES trades at 7x eps and 5x ebitda.  There are reasons for some of this discrepancy (i.e. smaller market cap, trading in Canada, little sell-side analyst coverage), but the bottom line is that as investors better understand Secure’s business I believe this gap will narrow.

Management has started to take steps to help investors recognize the mis-valuation of their assets.

1)      Resegmentation:  During 1Q23 they re-segmented their business to demonstrate that only 10% of earnings was coming from oil services.  Prior to this it was difficult to see how much of their business correlated to energy.  On 12/11/23, during the divestiture conference call, management further re-segmented by eliminating the oil services segment as it is now immaterial. 

2)      Management recently divested 3 small non-core assets and the last one closed in Dec ’23. 

3)      Analyst community:  Mgmt has started attending waste management conferences and talking more to analyst who cover this sector. Historically, only energy service analysts have covered the stock.

4)      Replacement costs: Mgmt believes it would cost $5b+ to replicate their assets and getting permits would be nearly impossible. 

Catalyst:  Asset Sale

The key to my bullish thesis is the accretive asset sale that is set to close during 1Q24.  SES has announced they will sell 29 (formerly Tervita) facilities for $1.15b or 45% of the current market cap.  This will be followed by a Dutch Tender for 20-40% of the company!

It may be helpful to understand a little background on the Tervita Acquisition. First, Secure announced the Tervita deal on 3/9/21.  They closed the acquisition 7/2/21.  It was an all-stock deal: ~$500m equity plus assumed $700m net debt for ~$220m ebitda. The attractive deal price had to do with the challenging conditions caused by covid. Also, this deal removed pending legacy litigation between the two companies. The CEO was confident this would go through the regulatory process without an issue.  However, almost two years later, on 3/3/23, the Tribunal demanded Secure divest 29 facilities citing failure to meet the efficiency defense. The stock was downgraded by 2 sell-side firms and fell 30% the following week.  Secure filed an appeal within 30 days citing “errors of fact”.  The Federal Court of Appeals rejected the appeal, and the Supreme Court of Canada was in the process of reviewing the decision when SES announced a sale of the assets in dispute.  It should be noted that while this legal process was ongoing Secure got to keep the earnings and cash flows.

This transaction is very positive for Secure for several reasons:

1)      WCN is paying 7.4x ebitda (TTM as of 9/30/23) which was above the valuation of Secure of ~5x ebitda, so it is accretive.

2)      I have heard that 20 companies were interested in the Tervita assets, and 10 were large companies, trading at double digit ebitda multiples and do not need additional financing.  This could lead to an acquisition of the rest of Secure’s assets. 

3)      There are several logical acquirers including RSG, CLH, GFL. It would be massively accretive for all of them even without synergies.  Also, note that RSG just increased their credit facility in Canada despite having their headquarters in Arizona.

4)      Previous transactions in this sector have been done for ~10x ebitda (see table below), so I believe that is a reasonable multiple assumption for the rest of Secure.

 Additional Key Points:

1)      This is shareholder friendly management with great alignment.  CEO Rene Amirault is the founder and has 95% of his net worth in the stock.  He personally bought stock on 5/4/23.  Insiders own about 7% of the shares outstanding. Most recently, on 12/13/23, Board Member Wendy Hanrahan purchased 11,500 shares for $8.71.

2)      TPG/Angelo Gordon, the largest shareholder with 18% of the float, added to their position on 7/10/23.

3)      In 3Q23, the share count was -6% y/y, so management is buying back stock even before the asset sale.

4)      Secure has some high-cost 11% debt that just turned callable on 12/1/23.  I expect this to be taken out soon and result in interest expense savings of $23m/yr.

5)      5% dividend yield.  This dividend, in addition to the ongoing buyback, speaks to the healthy free cash flow generation of this business.  It is also noteworthy that the dividend was raised 33% back in Dec ’22.

6)      Leverage as of 3Q23 is 1.8x and is going lower due to free cash generation and, of course, the asset sale. Target leverage is 2-2.5x

Why does this opportunity exists?

Investors were waiting for the asset sale before stepping in.  Investors don’t like uncertainty and until last week investors were concerned over the price Secure may get and what they will do with the proceeds.  I am confident now that the deal has been announced that investors cannot ignore the value and will re-rate the stock.

Financials/Valuation

Below are summary financials to demonstrate the impact of the impending divestiture.  I assume ebitda grows 8% for each of the next two year.  This is a conservative assumption since organic growth is 5% per year and incremental margins have averaged 40% over the past 3 years.  Plus, over the past few years, Secure has invested in a growth project called Clearwater.  It required a $45m investment and will generate a $15m/yr return with a 10-year term starting in 2024. There is strong visibility because this is a take-or-pay contract.  Clearwater is one of the reasons Street estimates are too low.  The other reason is that I assume Secure gets to the low end of their target leverage of 2x-2.5x through buybacks over the next 12 months.   

You can see how the valuation moves from 5.4x ’25 ev/evitda pre-deal to 4.6x post-deal.  Also, the FCF yield moves from 12.9% ’25 to 17.0%.  Street eps estimates are way too low.  The Street assumes $0.63 eps in ’25 and I believe 2025 eps will be $1.20 or almost double current expectations.

Target Price

My 2- year base case target price is $19, which is 125% upside if you include the dividend. That target uses an 8x multiple on $507m ebitda in ’25.  I think 8x is reasonable considering the quality of the assets, the fact that they will have just marked-to-market assets (that are less attractive) at 7.5x, the robust dividend yield, and replacement value.

My bull case target price is $25.2, which would be a 10x multiple which is closer to waste management peers of 12x.  Yes, this scenario incorporates considerable multiple expansion, but I think it reflects the uniqueness of the assets and the scenario where the entire company is taken-out. 

Risks:  The main risk is that Secure decides to not do a buyback and overpays for a large acquisition instead.  I view this as unlikely as the CEO said the highest multiple he would pay is 8x and only if significant synergies.  Another risk is that this stock is a smaller cap Canadian company, so subject to market risk-off events.

Conclusion

I want to emphasize the very limited downside in the stock here. First, you get paid a 5% dividend yield to wait. Second, the company was buying back 6% of the market cap per year even before the recent asset sale and would get more aggressive at lower prices. Third, you have a company that is under-levered and is growing organically.  Once the Tervita assets are sold, the company can re-focus on tuck-in acquisitions to supplement organic growth. Lastly, if I am wrong, you don’t lose much, but if I am right the stock will re-rate and generate 125% upside in short-order.  If the company ever trades near a waste multiple or is acquired you make 200% on your investment.

Catalyst

1)      Take-out or refinance the $207m of 11% debt

2)      Buyback begins via NCIB (normal-course issuer bid)

3)      Divestiture closes in 1Q24

4)      Dutch Tender announcement after divestiture closes

5)      Quarterly earnings

6)      Raising annual guidance throughout the year