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Tuesday, September 29, 2009

Hazardous Waste Redux + August Durable Goods Down 25% Y/Y

This is a long overdue update to our 7/3/09 post, Hazardous Waste Cos Hazardous to Health, For Now regarding Clean Harbors (CLH, $57.19) and American Ecology (ECOL, $18.73). In that post, we noted that 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). However, we also expressed concern that these are cyclical companies and fundamentals were still deteriorating. We also mentioned indications of intense pricing pressure from an industry contact. Both companies had previously highlighted weak trends in their 1Q09 reports and lowered 2009 guidance.

While share prices are slightly higher since our prior post, 2Q09 reports for the companies included a bit of déjà vu as weak conditions weighed on results and the outlook. Revenue and operating income for the quarter were down 19% Y/Y and 45% Y/Y, respectively, for Clean Harbors, and down 18% Y/Y and 42% Y/Y, respectively, for American Ecology.

Here's what Clean Harbors relayed in its 8/3/09 press release (we include a fair amount of text herein to provide context):
  • “While we experienced a sequential increase in revenue from the first quarter, our second-quarter performance fell short of our expectations as the challenging economic conditions continued to weigh heavily on several areas of our business,” said McKim. “Specifically, our results were affected by a number of factors including project delays by customers; ongoing weakness within our chemical, manufacturing and utilities verticals; and limited emergency response work.”
  • “Within our Technical Services segment, our results for the quarter were mixed,” McKim said. “Utilization during the quarter at our incineration facilities, which includes most of the 50,000 tons of capacity added in the past year, was 88%, consistent with the prior year level. Landfill volumes were up 10% year-over-year, although down from first-quarter volumes as a result of the significant reduction of project work. Our TSDF locations and general labor and transport business saw an overall decline as a result of the ongoing slowdown in certain industry verticals. A bright spot within Technical Services during the second quarter was our solvent recovery business, which continues to be a steady contributor. We made some enhancements to our Ohio facilities during the quarter to further capitalize on our momentum in this area. In addition, we remain on track with the second phase of our solvent recovery plant expansion at our El Dorado location, which we anticipate will be completed by the first quarter of 2010.”
  • “Within Site Services, we experienced a steep drop-off in projects, particularly from our petrochemical, specialty chemical, manufacturing and utilities clients, which are continuing to conserve their capital,” said McKim. “The silver lining to this shortfall is that the vast majority of these projects have been delayed rather than cancelled, and we are beginning to see a pick up in activity this quarter.
  • "Based on the Company’s first-half performance and current market conditions, exclusive of the Eveready acquisition and related costs, Clean Harbors expects full-year 2009 revenues in the range of $925 million to $950 million, and EBITDA in the range of $143 million to $150 million. Previously, the Company had projected 2009 revenue growth to be flat to slightly down, compared with $1.03 billion in 2008, and 2009 EBITDA in the range of $163 million to $167 million."
And American Ecology on 7/28/09:
  • "Weak economic conditions and more competitive pricing adversely impacted our business through the second quarter," commented Steve Romano, Chairman and Chief Executive Officer. "Waste volumes were much lower than the second quarter of 2008, only slightly above volumes received in the first quarter of 2009. However, recurring Base business with refineries and waste brokers held up relatively well, however, as we continued to strengthen our relationships with key customers and brokers. We are also pleased with our thermal desorption recycling operation in Texas, which continued to meet throughput expectations."
  • The Company reaffirms its 2009 earnings guidance range of $0.85 to $1.00 per diluted share. Management believes achieving the upper end of the range will be difficult without accelerated government spending and increased private sector clean up activity in the second half.
  • "The unsettled economic conditions amplify the uncertainty inherent to the disposal industry particularly with regard to the level and timing of event clean-up business," Romano commented. "Discretionary private sector clean-up schedules continue to lag and, while we expect to receive American Recovery and Reinvestment Act funds for multiple projects, specific timing and amounts are not presently known. The current economic climate has also led to downward pricing pressure on certain disposal and thermal processing services, which is impacting margins."
  • "Looking forward, we believe the long-term outlook for clean-up work is favorable based on pent-up demand from deferred private sector clean ups and a revitalized emphasis on environmental remediation by the federal government. With a solid foundation of recurring base business, efficient, upgraded infrastructure at our operating facilities, new service offerings and a debt-free balance sheet, American Ecology is well positioned to take advantage of long term business drivers, an improving economy and acquisition opportunities," Romano concluded.
SO, cautious commentary about the current weak state of affairs -- probably not surprising -- along with a few positives mixed in providing support for the long-term investment thesis (e.g. solid balance sheet, need for services, etc.). In fact, shares appear to have support at current levels given very attractive franchise characteristics and long-term, normalized earnings power. We understand why many investment firms with patient capital established initial or added to positions during the June quarter - see this Nasdaq.com link and note firms such as BAMCO, Epoch, Gilder Gagnon Howe, Pictet, TCW, and T. Rowe Price. From a free cash flow perspective, Clean Harbors generated TTM FCF of $54 million for an implied yield of 3.6% (not pro forma for $409 million Eveready purchase). American Ecology generated TTM FCF of $21 million for an implied current yield of 6%.

Nonetheless, we believe a recovery in industrial demand and, therefore, hazardous waste creation/collection will likely remain sluggish into 2010, pressuring fundamentals (which probably explains why shares haven't fully participated in the ongoing Market rally). In this regard, trends in durable goods are probably a helpful indicator to track -- M/M data from the U.S. Census Bureau:
On a M/M basis, August turned negative following a bounce in July that was helped by increased orders for aircraft, communications equipment, and the cash for clunkers program -- see Bloomberg story re: July increase. We continue to believe that Y/Y trends are critically important and share this information from a Zacks report re: August figures:
  • "The numbers on a year-over-year basis are still rather dismal. Total new orders are 24.9% below a year ago, while excluding transportation they are down 22.2% (given the extreme fluctuations in transportation orders from month to month, it is interesting to see just how close the two are on a year-over-year basis). If Defense orders are excluded, we were ... off 26.6% year over year."
Looking at this graph, we will say that the slight uptick from the recent trough is encouraging. As we've discussed in the past, Y/Y comparisons will soon become very easy for virtually all sectors of the U.S. and global economy. Stabilization and/or slight Y/Y growth off of very easy comparisons should provide another psychological boost to the American public and the Market, even with slack industrial production and high unemployment.

For now, we stay on the sidelines and keep watching CLH/ECOL, as well as some other waste related names such as small-cap Casella Waste Systems (CWST, $3.04). We're not opposed to purchasing cyclical names trading at a discount to normalized earnings power and/or estimated replacement cost, but retain our preference for current growth and significant, consistent excess cash flow with limited capital requirements. Examples we own include American Oriental Bioengineering (AOB, $4.95), j2 Global Communications (JCOM, $23.15), and eBay (EBAY, $23.92) -- please see our prior posts. Except for EBAY, AOB and JCOM have not materially participated in the Market rally and offer estimated 2009 FCF yields of 16% and 9%, respectively. One concern, however, regarding JCOM is recent insider selling, which is often a red flag (if in size) and we were surprised to see (even if some relates to tax bills).

Happy investing,

Jeffrey Walkenhorst

Disclosure: long AOB, EBAY, JCOM.

© 2009 Jeffrey Walkenhorst
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