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Friday, July 3, 2009

Hazardous Waste Cos Hazardous to Health, For Now

Two companies we analyzed over the past year are Clean Harbors (CLH, $54.11) and American Ecology (ECOL, $18.00), both of which are engaged in the business of collecting hazardous and non-hazardous waste. American Ecology even handles radioactive waste, which is a highly specialized endeavor. Each company has established powerful franchises that arguably operate with insurmountable barriers to entry that, therefore, make them fantastic businesses from an owner's perspective (*although capital intensive). Aside from strict compliance with federal regulations and zoning/permit requirements, examples from Clean Harbors 2008 10-K:
  • Leader in consolidated industry: "We believe that the number of major industry participants in the North American hazardous waste sector has declined from over 20 in the early 1990s to four national companies today.... We service approximately 67% of North America's commercial hazardous incineration volume and 20% of North America's hazardous landfill volume, and are the industry leader in total hazardous waste disposal facilities. We perform environmental services for a diversified industry base with over 47,000 customers, including more than 325 Fortune 500 companies, in the United States, Canada, Puerto Rico and Mexico."
  • Facilities that no one wants in their backyard: "Included in our 51 active hazardous waste management properties are six incineration locations, nine commercial landfills, six wastewater treatment plants, 20 TSDFs, two solvent recycling facilities and eight facilities which specialize in PCB management, oil and used oil products recycling."
  • Large share of physical capacity in North America: Clean Harbors notes that it owns six of only 11 major incineration facilities in North America used for disposal of hazardous wastes. On the landfill side, Clean Harbors states that it owns seven of only 20 active commercial landfills in North America used for disposal of hazardous wastes.
As shown below, shares of both companies are well off highs of last year, even with both names up approximately 30% from March lows. Further, we are fairly confident that the replacement costs for both companies are well above current market values, providing protection for long-term investors. Finally, both companies have shareholder friendly management teams and very clean balance sheets with minimal debt. They can easily ride out the recession.

However, we remain on the sidelines for one primary reason: these are cyclical companies and fundamentals are still deteriorating. Our conversations with a contact in the traditional waste business suggest volumes continue to soften. Moreover, pricing power that the waste industry experiences in normal to good times could be working in reverse as our contact cited up to 20% price reductions to drive better volumes. We suspect that conditions in the hazardous waste business are no better as the industrial economy remains depressed with low capacity utilization across sectors. Weak trends were noted by both Clean Harbors and American Ecology in 1Q09 results, and both companies lowered 2009 guidance. A 6/1/09 article in the Waste Business Journal includes results from an industry study that cites:

  • "the first decline in residential waste generation in more than twenty years.... [and] an even more significant decline in commercial and industrial waste generation, particularly the 20% decline in construction and demolition wastes (C&D) that are closely tied to the economy."

The article also notes that waste firms "managed to hold the line on pricing", although we're not certain this will be the case for companies in different market segments and regions around the country.

While the bottom is impossible to call -- and we don't believe consistently timing the market is possible -- we do believe in payng close attention to fundamentals. As noted in prior posts, we're inclined to expect the worst in the current environment and, therefore, think hazardous waste companies could be hazardous to near-term financial health. Fow now, we wait and focus on companies with more favorable 2009 growth prospects and, preferably, significant excess cash flow generation.

Happy investing,

Jeffrey Walkenhorst

Disclosure: none.

© 2009 Jeffrey Walkenhorst
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