Houlihan Lokey analysis finds positives in waste and recycling sector

A Spring 2020 analysis by Los Angeles-based Houlihan Lokey of publicly traded firms in the environmental services and waste management sector has found business models that “have proven more resilient than most” in holding onto revenue in the COVID-19-related turmoil of 2020.

The analysis, co-authored by Scott Sergeant, Disha Mehta, Jordan Mendel and Leon Vayntraub, says the resiliency of the sector has been helped by its “nearly universal designation as ‘essential,’ regulatory support, and focus on safety and continued environmental stewardship through this period of uncertainty.”

The 17-page analysis places seven companies in the environmental services category and five others in a waste management category. The five categorized as waste management firms are Vermont-based Casella Waste Systems, Toronto-based GFL Environmental Inc., Phoenix-based Republic Services Inc., Toronto-based Waste Connections and Houston-based Waste Management Inc.

The seven companies placed into Houlihan Lokey’s environmental services category also offer waste and recycling services. Those firms are Massachusetts-based Clean Harbors, New Jersey-based Covanta, Illinois-based Crystal Clean, Pennsylvania-based Harsco Corp., Illinois-based Stericycle, Idaho-based US Ecology and France-based Veolia, which has North American operations based in Boston.

In terms of these firms’ stock valuations, the analysis found that first-quarter 2020 earnings “remained strong,” but also that many of the 12 firms “have suspended guidance for full-year 2020.”

Add the report authors, “Waste management companies have all shown a strong performance and rapid recovery from March lows, and residential-focused names have experienced the strongest rebound (Casella). While trading history is limited, GFL’s stock price has already bounced back to above its March 3 IPO [initial public offering] price.”

Among the five companies in this sector, “Performance has been generally well insulated from economic cycles due to the essential nature of services,” say the analysts. “While commercial volumes have been impacted, roll-off business has performed better, with both temporary and permanent pulls showing resilience.”

The report’s authors point to a “tale of two markets” exhibited by “a broad-based decline in commercial volumes [15 to 20 percent], with residential volumes up about 15 percent due to stay-at-home orders.”

In the waste sector, “Long-term capital allocation priorities remain unchanged,” according to Houlihan Lokey. “Cash flow production will remain positive for industry participants,” and “companies are committed to merger and acquisition goals when possible, and are ready to take advantage of potentially lower acquisition prices.”

Specific to recycling, the report’s authors write, “Programs are facing challenges, but companies are finding ways to maintain margins.” They note the “shutdown of municipal collection and sorting facilities over virus fears is creating a shortage of supply,” and that while the “decline in demand has put pressure on certain commodity prices, paper and cardboard have seen price surges due to higher demand from increased e-commerce activity during the pandemic.”

Among the seven firms in the environmental services category, when stock prices fall overall, as they did on June 11, it can lead to “artificially depressed multiples for the [Houlihan Lokey] Environmental Services index,” the report states. “Relative to forward earnings, environmental services companies are minimally down, while waste management names are trading at a premium to prior valuation,” according to the report.

The authors predict the second quarter of 2020 will have an impact on revenue and profitability in the two sectors, but write, “While all environmental services names have declined with the broader market since March, relative performance has been largely correlated to key end-market exposure, with names tied to health care (Stericycle, Veolia) holding up better than those with oil and gas or automotive customers (Harsco, US Ecology).”