There has not been a new hazardous waste landfill in the US in 15 years and it is unlikely any more will be approved in the foreseeable future. Surrounding communities screaming "not in my backyard!" have made it nearly impossible to get new facilities on-line. Yet, the waste stream has grown. Industrial USA now generates 40 million tons of hazardous waste each year, 5 million tons more than 5 years earlier. Simply, more industrial garbage is going to the same 21 landfills (as shown below).
But it is more than just the static number of landfills. Hazardous waste landfills are not uniformly placed. More than half the states don't have any while Texas and Southern California each have three. Moreover, each of the 21 hazardous waste landfills is permitted for only certain types of waste, creating transportation nightmares as trash crisscrosses the country to facilities able to handle them. For instance, Region V (serving Illinois, Indiana, Michigan, Minnesota, Ohio, and Wisconsin) has only one facility approved to handle PCBs. Radioactive waste is even worse: Only three landfills exist in the US capable of accepting radioactive material. In a nutshell, unless you are willing to pay high transportation costs, your trash options are usually limited to one or two landfills.
Only a few trash companies have hazardous waste facilities. Republic Services (NYSE:RSG) and Progressive Waste (BIN) don't have one. In fact, the 24 landfills capable of receiving hazardous (21) or radioactive waste (3) are owned by just 5 companies. Remarkably, two waste management companies, Waste Management (WM) and US Ecology (ECOL), control half the sites.
I want to draw your attention to tiny US Ecology (market cap $858 million). The Idaho-based Ecology owns 6 of the 24 radioactive (1)/hazardous (4) waste landfills (having just added Wayne, Michigan), secured through a series of opportunistic acquisitions (Stablex for $77 million in 2010, Dynecol for $11 million in 2012, and recently EQ for $465 million in 2014). Ecology's aggressive consolidation of these near-impossible-to-reproduce assets has gone unnoticed by the investing public, even as the company has created enormous increases in its EBITDA/share and revenue/share, far in excess of its peers. Ecology's audacious grab of hazardous waste facilities has narrowed the choices for the disposal of industrial hazardous waste allowing for future price increases.
Even with a bright future ahead, US Ecology has been treated like toxic waste, falling over 20% since reporting in November as investors mistakenly keyed in on one quarter's earnings forecast. Although the hazardous industrial waste company easily surpassed earnings and revenue estimates (topping earnings estimates by 19 cents and revenue estimates by 13 million), the market instead focused on the underwhelming 37 cent fourth quarter outlook, some 3 cents below analyst consensus, and fled the stock.
And yet, if you believe US Ecology will only make 37 cents, you surely believe in the tooth fairy. Knowledgeable investors know the weak guidance is a fiction: Management routinely low balls its guidance. For instance, US Ecology raised its initial 2014 forecast of $1.50 - $1.60 in Q1, Q2, and finally Q3 to $1.92 - $1.97. A similar pattern happened in 2013 as management lifted yearly guidance quarter after quarter.
Magical Fourth Quarters At US Ecology
But it is the fourth quarter in which US Ecology most clearly demonstrates its prowess at under-promise over-deliver. Historically, the company delivers superb fourth quarter beats, routinely crushing estimates year after year. The fourth quarter estimate trouncing blind-sides the shorts and it is easy to see why. Because US Ecology only gives a yearly outlook, the fourth quarter is the only period when investors can benchmark upcoming estimates. Take a look at the company's guidance from 2010 to 2013. Note that EPS exceeded outlook by 25% to 70%. In each of the last 4 years, the company reported earnings 8 cents to 14 cents above the mid-point of its outlook.
I expect the 10% short position will get slaughtered as US Ecology has once again set them up with its perennially underwhelming outlook. True to form, analyst consensus has adopted the very conservative 37 cents offered by ECOL. If history repeats itself, US Ecology will earn at least 46 cents (25% above its outlook) and maybe as much as 63 cents (should the company beat by 70% as happened in 2012).
In much the same way, US Ecology routinely surpasses its fourth quarter EBITDA guidance (on average by $2-3 million and always above the top of the outlook range). This time around, US Ecology forecast only $22.1 to $27.1 million in EBITDA for Q4, guidance that is absurdly low.
Why This EBITDA Outlook (And By Extension, EPS) Is Ridiculously Low
Last quarter, US Ecology surpassed EPS and revenue and came in with a robust $40.5 million in EBITDA, besting all of its prior reports of EBITDA by at least 2X. The breakdown is instructive. The recently acquired EQ division contributed $19.3 million while its legacy US Ecology contributed 21.7 million in EBITDA. Next quarter, US Ecology only expects $22 to $27 million EBITDA, about 40% lower than last quarter's $40.5 million. US Ecology blames the shortfall on EQ's seasonality (winter in the Northeast and end of year customer budget uncertainties). Assuming the legacy ECOL contributes $20 million (its average for the last 5 quarters), EQ would only need to add a teensy $2 million to $7 million EBITDA to make the guidance - a situation hard to imagine considering EQ has over $6 million a quarter in depreciation and amortization alone not counting earnings and interest. Besides, EQ made $54 million of EBITDA during 2013, making fourth quarter guidance even more ludicrous.
(From SEC)
Even without EQ, legacy ECOL by itself might make the numbers. Legacy ECOL has consistently increased EBITDA. Year-over-year, quarter EBITDAs have gone higher, suggesting the Q4 guidance of $22 to $27 million might be reached through its legacy business alone. Below are adjusted EBITDA for the last 9 quarters. Last quarter, EQ was included in the company's EBITDA (red arrow). Notice how year-over-year ECOL numbers have been trending higher. Add in next quarter's EQ contribution and ECOL will likely once again drive in another Q4 beat.
Catalysts Abound
As said, US Ecology operates in a niche category, running hazardous waste landfills in the US and Canada. The company has purchased 4 of these landfills in the last 7 years. Because of these acquisitions, Ecology can offer landfills that are closer to its customers, reducing transportation costs. Shipping expenses equal 15% of sales. Margins will improve as Ecology moves New Jersey waste to Michigan rather than Idaho.
Further, waste generators have fewer options as Ecology consolidates the space. To date, Ecology's acquisitions have been productive. Pricing has increased by an average 15% over the last 3 years (sourced from 10Qs and 10Ks) while landfill volume increased by average 11%. Ecology should see the benefits of scale from its recently purchased EQ (adds a Michigan hazardous waste landfill and hugely enlarges its footprint into the Eastern half of the US.) Previously most of its East Coast business was sent to its Idaho landfill via rail; now, that waste stream can go to Michigan.
More Catalysts
Catalyst #1: Bigger margins from repricing old EQ contracts.
Much of EQ's business was underpriced. In my conversations with management, Ecology plans on repricing EQ contracts to maximize margins, dropping customers where profits do not make the business worthwhile. Typical contracts run one to three years (most a one year duration).
Catalyst #2: A More Complete Trash Solution
The EQ acquisition adds technical services, remedial construction, emergency response, packaging and collection so Ecology can now offer its customers a more complete trash solution.
Catalyst #3: Ecology Benefits From Lower Oil Prices.
Cheaper oil will save money. Lower diesel makes for better bottom line.
On the EQ side of the business, especially on the services side, there's more -- we do more internalization of truck and routing of waste into the network. So there should be a positive impact on lower fuel consumption from that side of the company.
In an example of analysts not listening to the answers to their questions, Wells Fargo downgraded ECOL due to "uncertainly how lower oil prices will affect its business" despite management denying any negative impact. During the conference call, CEO Jeffrey Feeler noted "Justin, it's really not. It's not dependent on that. I mean, we're getting byproducts from just normal generation. So it's really not - it's not dependent on oil prices."
Last quarter, EQ had $14 million in transportation costs. With lower gas prices and closer landfills, I expect better margins.
Catalyst #4: The EQ acquisition diversifies the company geographically and adds service solutions.
EQ adds 6000 customers (including Kinder Morgan, Con Edison, and GE) and broadens Ecology's footprint into the Eastern half of the U.S.
Bottom Line
Through astute acquisitions, US Ecology has grown more quickly than its peers. Unlike its competitors, Ecology can get both favorable pricing and volume as the company secures irreplaceable hazardous waste landfills. Expect increasing EBITDA and EPS as the benefits of its EQ acquisition scale.
US Ecology should bash weak Q4 estimates just as it has in each of the last 4 years. I recommend using the 20% share price discount to BUY.