Description

SMED – Sharps compliance Is relatively small and unheard of company that holds extremely high barriers to entry, has established channel relationships and solves an industry pain for thousands of customers that is driven by sweeping regulatory mandates.

I first look at Sharps compliance when it was a super micro-cap at a 10mm dollar valuation but passed because it ‘kept moving away from me’ from .80 cents a shares to over $1….well shame on me because it is now north of $9 bucks a share but still I think an attractive investment opportunity.

The business:

Sharps Compliances focuses on the medical waste disposal industry but specifically on the small volume generators. So when you see the red bins in the doctor’s office for medical waste there is a stringent procedure on how that waste is disposed of, transported and a need to document the whole process. There are definitely lots of big player but they cater to large hospitals where sending a specialized truck and personnel make sense.

There are thousands of small volume generators of this waste. The most obvious are rural doctor offices, small practices, dental clinics, veterinarians. The less obvious outlets now include malls, hotels, restaurants and with recent regulation individuals self administering things like insulin. Recent regulation has required these venues and municipalities to handle waste in all of these settings. Sharps focuses exclusively on the small volume segment. They have a series of products which are self contained disposal units and mailers that are integrated. Their mailer has been approved by the United States Postal Service.

So if you are a mall (look for these in the bathroom next time you are in a mall or airport) and need to process medical waste you order these containers, mount them and then on some schedule fold them up and drop them into the mail pre-paid. Sharps handles the initial delivery, tracking, and ultimate incineration. They provide each customer with all the tracking and audit reports necessary to be compliant with the various regulations.

The beauty of the business lies in both the operational leverage, and the regulatory barriers to entry. The big disposal companies contract with Sharps to provide the small quantity product so they can offer a complete package, and they have a growing sales force to go after the other channels.

New entrants would need to contract with a medical waste disposal facility which are few and far between in the country, but more importantly would need to get their mailer through postal approval process and then demonstrate the compliance aspect of the product which I think is most valuable. Sharps has not only already certified their mailer and have been approved on the GSA schedule but they also own their incineration facility.

If you are a customer it simply not worth saving a few extra dollars to go with a cheaper upstart. The risk of switching simply does not justify the cost. I feel like their business has many of the dynamics that you see at companies like ADP or paychex.

Valuation:

The company got a large government contract that I think will persist. This doubled revenues and while many might view this as one time event I think the sales momentum the company is building in all the other channels is incredibly compelling. Considering the company’s fixed costs are now covered, incremental revenue tends to be very accretive to earnings as we have seen over the last few quarters.

The company’s sales have doubled in large part to a government contract which contains a product portion and then a maintenance portion. It’s a 5 year contract that is front loaded on the revenue and cost side and then reverts to a 4 year maintenance contract. The real growth driver here will be continued legislation by states that mandates municipalities handle consumer generated medical waste. California passed legislation recently to this effect and a few other states at a minimum will follow. In addition to this it seems like FEMA type programs want to stock the Sharps solution as an emergency prep product. The initial order and follow-on maintenance contracts could be very substantial and not reflected in the current earnings of the company.

They recently closed a secondary offering which was mostly insider selling (it is 60% insider owned so I think they wanted to get some liquidity and broaden the investor base).

They have 14.00 mm share out post the offering which included a small sale by the company.

Current price $9.25

14.0 mm shares

Market Cap  = 129 mm

Cash  = 9 mm

EV =  120 mm

So I think it’s hard to look at historical numbers since the company is currently at an inflection point and riding a growth curve that seems like it will continue albeit maybe not at the TTM rate. What is clear at looking at the last 3-4 years of numbers (in the presentation link below) is what the break-even levels of the business have been, and the fact that they truly do have tremendous operational leverage. Sales roughly doubled and so did profits. Management has routinely said that they have excess capacity and they seen no real cap-ex spend anytime soon. This all makes lots of intuitive sense as well.

The company is trading at

121/9.5 = 12X trailing taxed earnings

121/31 = 3.5 Revenue

and is growing at a fast clip. The company has ample expansion opportunities, high barriers to entry, a recurring revenue stream, and net cash and access to a credit line. This seems like an attractive valuation for a cash flow positive growth story. It certainly not starbucks in its infancy but seems like a business that can produce ample amounts of incremental cash with little incremental capital, and unlike a starbucks doesn’t need a good amount of capital to get there. Given the heighten health concerns of flu and impending legislation it seems like earning could easily double in the next 3 years if not more while generating cash in the process.

Check out the presentation here….you will understand the business very quickly.

http://www.sharpsinc.com/investors/20091021_SMED_Investor_Presentation.pdf

Risk: Operational Leverage works both ways!

Catalyst

Continued Legislative action by states similar to California Bill 486