The nuclear industry is a bit clubby. The expertise required to handle radioactive materials is hard to come by, placing only the most stalwart in the nuclear society. It is in that exclusive circle where investors can find Perma-Fix Environmental Services, Inc. (PESI), a provider of hazardous waste treatment and disposal services. Indeed, Perma-Fix is smart about all manner of toxic materials left over from power generation, industrial and commercial processes. Besides waste clean-up, Perma-Fix consults with industry in matters of safety, standards and efficiency for nuclear and other hazardous materials. Perma-Fix's expertise serves as a wide and deep moat around its business.
The protective circle has helped drive Perma-Fix profits. In the twelve months ending March 2012, the company earned $13.3 million or $0.24 per share on $133.1 million in revenue. That represents a net margin of 10.0%, significantly higher than the profit margin of 2.7% in the year 2010. Even more impressive is Perma-Fix's ability to convert sales into cash. In that same twelve-month period Perma-Fix rang up the cash register with a 10.1% cash conversion rate, comparing favorably to 7.9% in 2010.
A Sharp Turn Toward Product Innovation and New Markets
Historically Perma-Fix has waited for customers to generate hazardous waste and then call for treatment services. Now Perma-Fix is using its expertise to innovate new products - the moat gets wider.
Perma-Fix's engineers have come up with a proprietary technology for isotope separation including technetium. Called Tc-99m for short, it is widely used in medical tests. The Company expects to achieve commercial scale with its new process for Tc-99m within the next two years.
The timing could not be better. Tc-99m requires another isotope, molybdenum 99, which is now made in nuclear reactors using weapons-grade uranium. North America's supply comes from a 54-year-old reactor in Chalk River, Ontario. Its license expires in 2016 and efforts to develop alternative production capacity have fizzled. Smart about resins for treating contaminants at polluted industrial sites, Perma-Fix has come up with a resin that will hold an atom of molybdenum but release it when it decomposes into technetium. The Perma-Fix process is easily deployed using standard research and commercial reactors.
The medical community is concerned about shortages when Chalk River is no longer operational. Tc-99m is the most widely used medical isotope in the world, representing a $100 million market in the U.S. alone. It is used in thousands of heart, kidney and breast procedures a year because it throws off an easy-to-detect gamma ray that breaks down very quickly and gives only a small dose of radiation to the patient.
Perma-Fix expects to capture a share of the Tc-99m market, a feat that would add a significant new revenue stream to the Company's top-line in the years ahead. Management plans to engage a distribution partner with experience and contacts in the medical supply chain.
Strategic Acquisition Captures Market Share, Boosts Near-Term Revenue
Perma-Fix's results are getting a boost this year from the $17.9 million acquisition of Safety & Ecology Corporation Ltd. Completed in October 2011, the deal added $18.6 million to total sales in the March 2012 quarter, the first full quarter period Safety & Ecology had been a part of the mix. Safety & Ecology markets a menu of products and services: environmental engineering and consulting, health physics, contaminated land remediation services, and water and wastewater management. Safety & Ecology claims a respectable customer base, including the U.S. Departments of Defense and Energy.
Safety & Ecology's U.S. operations are located in Tennessee near two of Perma-Fix's facilities. Perma-Fix's largest facility, Materials & Energy Corp., is situated near Oak Ridge where the company claims the distinction of treating the largest variety of mixed low-level waste (MLLW) in the U.S. At nearby Kingston, the Company's subsidiary Diversified Scientific Services provides the only commercial service for the treatment of radioactive PCB waste.
Perhaps the most important business location for Perma-Fix is the waste treatment facility in Richland, Washington. At a 35-acre campus near the Department of Energy's Hanford Site, Perma-Fix treats low level and mixed low level radioactive waste for commercial and government customers, many of which are managing clean-up projects at SuperFund sites subject to the CERCLA (Comprehensive Environmental Response, Compensation, and Liability Act). Perma-Fix uses a proprietary macro-encapsulation process to treat debris and radioactive solids and then sends the waste off to permanent disposal sites managed by U.S. Ecology (ECOL) and EnergySolutions, Inc. (ES) as well as disposal sites managed by the Department of Energy.
Perma-Fix's relationships with U.S. Ecology and EnergySolutions are a bit complicated in as much as both also provide some waste treatment services. Moving into disposal and storage could eliminate the risk of being shut out of competitor-owned disposal sites. However, Perma-Fix's CEO Dr. Louis Centofanti is certain of Perma-Fix's focus on materials handling. Centofanti points out that disposal and storage are low value-added services and would not fully utilize Perma-Fix's expertise.
Indeed, the acquisition of Safety & Ecology last year appears to have greatly expanded the company's knowledge pool in treating and handling hazardous materials. The group has cutting edge technology for the detection of radiation and a first rate instrumentation laboratory to calibrate critical detection equipment. Such capabilities are in high demand by nuclear energy companies that must undertake frequent refueling cycles and need outside help to monitor radiation. Perma-Fix is expanding its addressable market for these services to the oil and gas industry. The hydraulic fracturing processes used frequently at natural gas wells often brings up uranium-laced waste water and Perma-Fix is advising drillers on how to keep sites clear of radioactivity.
A Solution for Customer Concentration
The 2011 acquisition of Safety & Ecology has helped Perma-Fix with a critical issue - customer concentration. Perma-Fix is a subcontractor to CH Plateau Remediation Company, which is the prime contractor managing clean-up of the Hanford Site, the U.S. nuclear production facility that was the home of the Manhattan Project. CHPRC is Perma-Fix's largest customer, contributing 49.9% of total sales in the year 2011. Even though the CHPRC relationship is solidified with a long-term contract that can be renewed, it is a big plus that with Safety & Ecology in the picture CHPRC's contribution to the mix is diluted.
Deep Value in a Growing Enterprise
Overall the Safety & Ecology deal beefed up service revenue to approximately 66% of the sales mix from 44% previously. Unfortunately, thus far the acquisition has also contributed an operating loss to the mix. There are apparently some cost savings potential through the elimination of duplicative administrative functions and other excesses. More importantly, management sees doors opening to new direct relationships with U.S. government agencies and a means to expand to new foreign markets. Japan's recent nuclear energy troubles make it a prime market for Perma-Fix's expanded monitoring, measuring and engineering services.
The drag on operating profit presented by Safety & Ecology might also be holding back valuation of PESI shares. The stock has traded off nearly 40% from its 52-week high price, with most of the decline since Perma-Fix reported a net loss in the first quarter 2012 results. Management is confident in a profit for the full year 2012 and believes the debt it took on to finance the 2011 acquisition is well justified by future growth potential.
Understanding Perma-Fix is not as difficult as it might seem with its laundry list of business locations and service offerings. Investors could be rewarded by taking the time to look beyond the bottom line and into Perma-Fix's market position that appears to hold both short-term and long-term opportunities. In my view, trading at 5.0 times trailing earnings, the stock appears oversold.
Please note that at the current price level PESI can be considered a micro-cap stock. Micro-cap stocks are characterized by price volatility, low trading volume and wide bid-ask spreads. This makes micro-cap stocks appropriate only for risk-tolerant investors.
Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.