Description

Stericycle: SRCL

Stericycle is a B2B regulated and compliance solutions service provider. They have seven different service lines:

1.   Medical Waste Management

2.   Pharmaceutical Waste Management

3.   Hazardous Waste Management

4.   Secure Information Destruction

5.   Compliance programs under Steri-Safe, Clinical Services, First Practice Management, SeguriMed, and EnviroAssure brand names

6.   Regulated Recall and Returns management communication, logistics, and data management services for expired, withdrawn or recalled products

7.   Live voice and automated communication services

Stericycle currently operates in 21 countries and has 256 processing facilities, 2 landfills, 22 communication centers, 325 transfer sites, 75 customer service/administrative offices, and 110 warehouse/parking facilities.

Stericycle has over one million customers ranging from small to large businesses. Most of these customers are in the healthcare business, but they also service retailers, manufacturers, financial service providers, governments and more. Presently, no customer accounts for more than 1.2% of total revenues and the top ten customers account for approximately 7.1% of revenues.

They have three reportable revenue segments – Domestic Regulated Waste and Compliance Services (Domestic and Canada RCS), International RCS, and All Other – and breakdown revenues into four categories.

Market Size / Industry:

The company claims to have ~10% of the $38 billion industry. The industries they operate in are highly regulated (especially the medical and hazardous waste one), which corresponds to part of the thesis. 

IBIS predicts the medical waste disposal industry will be growing at ~5.3% annually for the next five years, exceeding its 5-year historical 3% growth.

Breakdown of Operations:

Regulated Waste and Compliance Service Operations

The collection process for regulated waste begins at the customer’s location. Stericycle does not accept any material from its customers unless it complies with their waste acceptance protocols and is properly stored/packaged in previously supplied containers. This helps the company comply with regulatory protocols.

The company then collects these containers at the customer’s location. The collected waste is then transported to a transfer station. They use a transfer station as a hub to improve the efficiency of their collection process. It helps expand the geographic area that their processing facilities can serve, increasing volume and utilization of the facility. As mentioned before, they have 325 transfer sites and 256 processing facilities. 

Once the waste arrives at their processing site, they go through a secondary inspection ensuring no foreign or unauthorized substances are present. If a container is found to contain ‘unacceptable waste’ at this stage, Stericycle has a correction process. They either redirect the waste, return it to the customer or notify regulatory authorities. If there is no concern, the waste is processed at their facilities using a few different techniques.

•    Autoclaving: Uses high pressure and temperature to make medical waste non-infectious

•    Alternative Tech: Primarily used outside the US, this involves using non-incineration alternatives to kill pathogens. The waste is not always under pressure and may be shredded after treatment, depending on regulations in the region

•    Incineration: As the name implies, the waste is reduced to ash. It is the recommended disposal option since it reduces the volume of waste, however, in some cases, the air emissions or ash by-product from incinerating waste can also be subject to regulations

After the waste has been ‘treated’ or processed, the by-product is disposed of at a landfill owned by either a third party or (in 2 cases) owned by Stericycle. Again, depending on regulations in certain regions, the treated waste can be recovered to be processed into recovery fuel.

Processing and Disposing of Hazardous Wastes:

Hazardous waste is defined as ‘waste that has a substantial effect on public health’. Stericycle categories this, and expired goods, as hazardous waste. If the waste is expired, Stericycle deconstructs the waste to recover metals and recyclable components to reduce the overall volume. Pre-defined hazardous materials are categorized and grouped together before being sent to a processing facility. If they are unable to use their sustainable processes on hazardous waste, the waste is then sent to a third party for treatment.

Destruction and Recycling of Secure Information:

This operation is pretty simple. The company operates a popular brand called “Shred-It”. If the secure information is not shredded on site in a ‘Shred-It’ truck with their proprietary destruction technology, the information is then securely transported to a shredding facility. The documents are cross-shredded, baled (like hay), and then sold to an SOP.

Communications Solutions:

The communications solutions service provides live and automated voice services to assist with patient-client communication. They act as the intermediary assisting and completing common tasks (FAQs, appointment scheduling, event registration, etc). Stericycle also operates and expert solutions service line which guides their clients through recalls, retrievals, or audit processes. They brand themselves for ‘brand protection’ helping with notification services, call center services, removing the impacted product from distribution, processing recalled products and supporting remedy requirements, and compliance reporting. Their communication solutions line is highly customized based on the client’s needs. According to the transcript, this business has a 98% retention rate.

Monetization:    

Stericycle generates revenues through contracts with its customers. The nature of the contracts are client, operation, and geographically specific. Most are multi-year contracts and embedded with 8% annual price increases. Additionally, they claim to have a 90% retention rate amongst their customers.

Thesis:

Business Transformation Plan

In 3Q17, Stericycle initiated a Business Transformation plan with the objective of improving long-term operational and financial performance. The vision is to build an enterprise performance management operating model to streamline their portfolio, enhance their processes and organizational structure, and implementing an ERP (enterprise resource planning) system.

They have five key initiatives to tackle through the Business Transformation Plan:

•     Portfolio Rationalization: The company has completed 500 acquisitions over its 25 years in operations resulting in a “GE-style” business. The first objective is to identify non-strategic or essential assets and divest them

•     Operational Optimization: Along with those acquisitions, according to their transcripts, Stericycle’s global operations employ 450 applications and 65 different financial systems. These are just a few examples. This initiative is (as per its name) to optimize their operations including route planning logistics, modernizing field operations, and driving network efficiency.

•     Organizational Excellence and Efficiency: This objective seems to simplify the company’s organizational structure and align with their new operating model– Stericycle wants to operate under a ‘business services model’

•     Commercial Excellence: Nothing unique with this initiative. Stericycle wants to strengthen their customer relationships, ‘relationship management processes’, and expand its self-service offerings. This is likely due to the $295mm class action lawsuit they faced, which was settled in August 2018.

•     Strategic Sourcing: Reduce unnecessary spending through a global procure-to-pay process (more on this later).

Stericycle is hoping their plan will be completed by 2022 and will help achieve:

•       $850mm-$1bn in EBITDA benefits

•       85%-95% IRR

•       ~5%-9% AEBITDA CAGR

•       ~6%-10% Adjusted EPS CAGR

•       ~10%-14% Cash Flow CAGR

They have already achieved their 3Q18 milestones (and are on pace for FY18), but investors are discounting the stock due to missed revenue projections (which, when looking into, is also part of the business transformation plan). As of 3Q18, they have achieved:

•       Divested the Cleaning Room Services Business

•       Adjusted EBITDA benefits driven by additional strategic sourcing initiatives o $60-$65mm in EBITDA benefits for FY18

•       Completed design phase (first of three stages) for the end state processes

•       Slightly below budget expectations for FY18’s transformation plan

o   $65mm spent out of $95-$105mm expected for the year

Stericycle also hired a new COO and President – Cindy Miller – in September. Cindy Miller has 29 years of experience at UPS where she led the global freight forwarding team. She is in charge of heading the P2P transformation. The quote below explains the benefits of a strategic P2P process.

“Many organizations today still suffer from a fragmented approach to procure-to-pay (P2P), which leads to significant and avoidable inefficiencies. Taking a more strategic approach to P2P ownership means it's more easily possible to restructure the end-to-end process, leverage technology, provide a standardized service, and improve collaboration.”

In terms of portfolio rationalization process, Stericycle has/is:

•       Divested US-based non-core cleaning room service

•       Divested remaining hazardous waste service line in the UK

•       Divested Secure Information Destruction business in South Africa

•       Divested patient transport business in the UK

•       Divested hazardous waste business in the UK

•       Pursuing strategic alternatives for communication and related services and evaluating other non-core service lines and geographies.

Another major point, which sell-side and the market have missed, is that the company missed revenue estimated last quarter largely due to divesting many practices. One of the practices, according to their transcript, caused a decrease of almost $9mm in revenues. The total impact of all their divestitures is difficult to locate, but the majority of the decline/miss can be attributed to the sell-off of many of their businesses. Another $17.3mm loss is attributed to forex impact.

Strong Capital Allocation / Acquisition Machine

Stericycle is an acquisition machine and has completed 104 acquisitions in the last 3 years. Management has been effective in allocating capital, resulting in increased market share and revenue growth. 

While the company did announce they would be divesting of ‘non-strategic’ acquisitions, it is possible that future acquisitions will provide further synergies to the overall business.

“We expect to continue our acquisition strategy, remaining focused on small, highly accretive, tuck-in acquisitions that broaden our various service capabilities”

~ Management in MD&A section of 10K

Trading at a Discount

Over the last three years, SRCL’s stock price has been punished for one-time headwinds:

1)     October 2015 – Foreign exchange rates negatively impacted their 3Q profitability

2)     May 2016 - $65mm goodwill impairment reported on 1Q earnings

3)     August 2016 – Accounting errors causes a huge miss (17%) and reports of litigation

4)     February 2018 – Divestitures as part of upcoming Business Transformation caused revenue to miss estimates

5)     August 2018 – Settlement of class-action lawsuit

This has caused Stericycle to be trading down from its historical $140 price range. While this is not independently a reason to purchase SRCL, it provides an opportunity to invest at a steep discount.

Strong Moat:

Last but not least (for the pros), the business is highly regulated (especially with their medical waste division) resulting in high barriers to entry. In order to dispose of medical waste, one must comply with local/regional governmental procedures. They also must obtain a renewable permit, registration or license to operate in some divisions. They must also comply with environmental law procedures and medical transportation procedures. In the US specifically, the EPA does not have federal guidelines for medical waste, SRCL must comply with state-level guidelines. From another standpoint, waste disposal has high capital costs to ensure adequate infrastructure. The process for obtaining these permits and the high capital costs may take years to procure.

Additionally, small individual clients experience high switching costs and low optionality. It is generally cheaper for these small companies to contract out the disposal process than to put it in house. The prices for medical waste disposal vary since there are a lot of variables (type of waste, length of decomposition, quantity, frequency etc.).

Risks:

Pricing + Demand

There is a lot of negative pricing sentiment with Stericycle with no outlook on the future. The company assures investors that the downturn is only temporary and they are combatting it with increased acquisitions - but they may continue. Also, the nature of the contracts is not clear. Initially, Stericycle had embedded 8% annual price increases. However, with the recent lawsuit, the terms of the new contracts has not yet been released (expected with Q4 results). As such, future pricing is difficult to predict and get comfortable with.

Catalyst

Catalysts:

• International / developing countries with increased medical programmes

• Age – baby boomer generation

• Transformation occurs faster than expected or has better than expected results.