US Ecology, Inc. (NASDAQ:ECOL) has been operating in the waste disposal and management industry for nearly 60 years and providing services such as hazardous, non-hazardous and radioactive waste disposal to customers in a variety of industries. It has operating facilities in several U.S. states and one in Canada. While the US operations contribute about 77% of revenue, the Canadian side accounts for about 23%. Besides having operating and non-operating facilities on government owned and company owned land, the company also owns a rail car fleet used to transport materials for disposal. It generates its income broadly through the segments - Treatment and Disposal (T&D) as well as Transportation. While the Transportation business helps the company to clinch contracts by offering useful bundling of services (and can be up to 75% of the project cost), it is offered near or at cost. The main earnings stream comes from the T&D side, which can be divided into the Base Business (65% of revenue) and the Event Business (35%). As the name suggests the Base business comprises the stable, recurring waste disposal service that US Ecology's customers require as a product of their daily operations. The Event business is based on cleanup due to non-recurring situations, for example a hazardous substance spill, and is much more volatile.
The company has been reporting strong financial results for the last four quarters with positive earnings surprises. Most recently in Q2 2013 its year-over-year results showed nearly a 15% increase in revenue with growth in both base and event segments. While volumes were down in the second quarter, a double-digit increase in average selling price based on service mix helped bolster revenue. Also, the transportation segment revenue grew by a healthy76%. Most of the business lines performed well, but the government sector revenue declined heavily due to budget cuts. However it was offset by strong commercial sales. Also management remains optimistic of new budgets restoring activity to previous levels in this segment next year.
There was approximately 13% growth in operating as well as net income. Diluted EPS was up 11% to $0.39. Profitability metrics were also solid with a return on equity of about 24%, return on assets 12% and return on invested capital nearly 16%. The acquisition of Dynecol (now US Ecology Michigan) continued to contribute increasing amounts of revenue to the business. While year-over-year growth in the top and bottom line in Q2 was not as aggressive as its counterpart in Q1, management expects the remainder of the year to be strong due to projects started earlier in the year that will continue to yield income in the latter half.
The company has been consistently paying a dividend of $0.18 per share for several quarters now and if management's optimism regarding the project pipeline materializes, it should be able to generate enough cash going forward to continue to pay dividends, invest in capital projects and payoff portions of the revolving credit.
The waste disposal business is extremely competitive both in terms of price and service. US Ecology is a relatively small company in comparison to some of its direct competitors like Waste Management and Republic Services and faces tough competition to acquire large projects. Additionally the industry has over capacity since the 90s along with a reduction in event-based business opportunities over the years, which heats up the competition even more.
It operates in a high fixed cost industry, where costs of facility acquisitions and expansions as well as costly licensing processes add up to a high debt burden. In Q2 2013 while the company had $43 million in debt (with about $43 million of available credit lines) it had only $4 million in cash, putting the company in an unfavorable net debt position. However its debt-to-equity ratio of approximately 35 is well below that of some of its larger direct competitors.
The company carries a large amount of insurance coverage due to the nature of its business. Besides the cost associated with this, there is risk generated by policies covering U.S. facilities that are due to expire at the end of 2013. While the company expects to successfully renew these, a failure to do so can cause big losses from successful claims and/or regulatory action. It is also required to meet financial assurance requirements for its facilities through insurance, letters of credits and bonds and any increase in such requirements can negatively impact the business.
Waste disposal and management is seasonal in nature, besides being impacted by changes in federal funding and economic activity. Additional margin volatility for the company comes due to high dependence on one-time "events". Since it handles hazardous waste, it is a business that is vulnerable to compliance failures resulting in litigation and fines.
Strategy and Opportunity
US Ecology plans to expand its base business to cover fixed costs and use the event business to generate income streams. Along with having healthy returns on assets it also plans to maximize the usage of assets like its railcar fleet for better returns. It plans to develop its niche services and expand service lines while competing for larger projects. In the past the company has grown through acquisition of facilities, transportation infrastructure, licenses and treatment techniques and is moving forward in that direction.
A continuous source of opportunity for the company comes from environmental laws and regulations, which create demand for its services. The costs and specialized knowledge required to obtain licenses to operate in the industry also create a barrier to entry for new competition. The company already has many such specialized permits, which secure its position and can provide new business opportunities. Also brand recognition, safety and compliance records can attract more business for the company. For example, the LARM business is one of the areas where management sees growth opportunities.
Another factor that provides some stability to the company is that the customer mix is diversified with no single customer providing over 10% of revenue for the company in the last 3 years.
Price and Valuation
At the time of writing ECOL was trading at approximately $28, which is above its 200-day moving average, but very close to the minimum price calculated from historical data since the last earnings. This is also below the consensus price target and roughly $6 below its pre-recession high point. But at $28 it is also more than four times book value per share, which is actually greater than some of its direct competitors such as Waste Management and Republic Services. In the last year the maximum price has risen to around $30 immediately following the Q2 2013 earnings call and has been lower since. It has a trailing P/E of 19 and forward P/E of 16, which is below industry average but the price-to-sales ratio is higher than some major direct competitors. Given recent price performance it could be a good buy below $27.5, given future expectations materialize.
US Ecology has shown strong financial performance in recent quarters and management is confident that the project pipeline will help continue this momentum. The company has the advantage of already having several licenses and permits, which pose barriers to entry for other competitors. I expect that demand for smart solutions for waste disposal are likely to grow in the future as environmental consciousness increases. As long as US Ecology can keep innovating in service mix and disposal "recipes" I think it can beat its larger competitors through greater profitability and continue to pay dividends to its shareholders.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am a self taught individual investor and this article expresses my views based on my own research. I am not being influenced or paid by any organization to write this article.