Harsco Corp (HSC) is a diversified, multinational provider of industrial services and engineered products. The company's operations consist of two reportable segments: Harsco Metals & Minerals and Harsco Rail. The company has locations in 30 countries, including the United States.
|Insider/Institutional||1.0% / 88.3%||ROE LTM|| |
|Public Float||79.3 million||Book Value/Share|| |
|Market Capitalization||$2,004 million||Daily Volume (3 mo. Avg.)||384,349 million|
|FYE DEC||FY 2018A||FY 2019E||FY 2020E|
|FYE DEC||FY 2018A||FY 2019E||FY 2020E|
|Revenue ($ mil.)||ACTUAL||CURRENT||PREVIOUS||CURRENT||PREVIOUS|
- Q1:19 revenues were $447 million, up 10% from Q1:18, largely attributable to an increase in the Rail (+15% YOY) and Industrial segments (+40% YOY), partially offset by the Metals & Minerals (-1% YOY) segment.
- HSC delivered non-GAAP operating margin of 9.3%, compared to 9.4% in Q4:18 and 9.0% in Q1:18. Adjusted operating income increased ~14% to ~$42 million.
- HSC announced a series of transactions (acquisition of Clean Earth and sale of Air-X-Changers) which accelerate its shift to an environmental solutions-focused company comprised of higher-growth businesses with enhanced margin profiles and reduced cyclicality.
- HSC noted that the backlog trend across segments is positive which should boost revenue in FY19.
- For FY19, HSC raised its guidance with adjusted operating income at $207-$222 million (earlier $200-$220 million) and adjusted EPS at $1.35-$1.53 (earlier $1.29-$1.47).
- We marginally adjust our estimates based on the results and management commentary. We maintain our BUY rating and increase our target price to $32.25, with an implied capital appreciation potential of29%.
- A slowdown in global steel production and demand could adversely affect the M&M segment (HSC’s largest revenue contributor).
- Difficulties with integrating acquisitions could adversely affect operating costs and expected benefits from those acquisitions.
QUARTERLY SUMMARY – Q1:19
- Revenues up 10% vs. prior year. Total revenues were up 10% to $447 vs. $408 million in the prior year quarter and up sequentially vs. $436.9 million in the preceding (December) quarter. We had a forecast of $451.5 million. The increase was largely attributable to strong performance in the Rail (+15% YOY) and Industrial segments (+40% YOY), partially offset by the Metals & Minerals segment (-1% YOY).
- Adjusted operating income up ~14%. HSC delivered non-GAAP operating income of ~$41.7 million versus $36.5 million in the prior year quarter. Adjusted operating income in the Rail (+311.7% YOY) and Industrial segments (+37.1% YOY) improved, while the Metals & Minerals segment (-18.5% YOY) declined in comparison with the prior-year quarter. The adjusted operating income margin stood at 9.3%, compared to 9.0% in Q1:18.
- Strategic initiatives. HSC announced a series of transactions which accelerate its shift to an environmental solutions-focused company comprised of higher-growth businesses with enhanced margin profiles and reduced cyclicality. These transactions include the acquisition of Clean Earth (value $625 million) and the divestment of its Air-X Changers business (for $592 million). Both transactions are expected to close in the next few months. Clean Earth is a leading specialty environmental services business that processes and treats waste streams in the U.S. Clean Earth has an attractive growth profile and is projected to deliver sales of $300 million and EBITDA of $65 million. Meanwhile, Air-X-Changers is projected to generate revenues of about $275 million this year and EBITDA of $60 million. These transactions align with the Company’s strategy to decrease complexity of the portfolio, focus on less cyclical industries, and pursue higher growth businesses with strong margins.
- Rest of Industrial Portfolio to be sold soon.Management plans to sell the remaining two Industrial businesses (IKG and Patterson-Kelley) soon. Proceeds from the sale of these businesses will be used to strengthen the balance sheet and to support investing in the core environmental solutions and rail businesses. IKG and PK combined are forecasted to generate EBITDA of ~$20 to $22 million in 2019.
- Order backlog trend positive. HSC noted that the backlog trend across segments is positive which should boost revenue in FY19. Rail backlog was stable sequentially during Q1:19 and remains more than 100% higher than year ago levels.
- Adjusted EPS up ~32%. The adjusted EPS was $0.29 in Q1:19, exceeding management’s guidance range of $0.20 - $0.26. It was ~32% higher compared to the prior year period. The primary drivers for the increase were improved operating results and a lower than expected tax rate for the quarter.
Management remains confident about the prospects of each business segment in 2019. We assume no contribution from the Industrial business from Q2:19 onwards given management’s intention to monetize the segment soon. Instead, we factor in the Clean Earth acquisition from Q2:19 onwards. The company made significant investments in the M&M segment in FY18, including the acquisition of the Altek Group. M&M signed 28 renewals and 12 new contracts during 2018. In 2019, we expect a healthy lift in revenues (mid to high single digits) due to the investments and new contracts that will commence in the first half of the year. For the Rail segment, management expects revenues to increase ~30-35% YOY.
For 2019, management anticipates operating margins to increase across its business segments. For the M&M segment, management expects adjusted operating income to increase by a high single-digit percentage. For the Rail segment, management of HSC expects operating income to grow in line with revenue growth. For the Industrial segment, operating income is anticipated to increase ~20-25%.
For 2019 and 2020, we forecast revenue growth of 6.6% and 3.6%, resulting in $1,836.4 and $1,902.2 million of revenue, respectively. We note that the two Industrial businesses (IKG and PK) contributed ~$169 million in sales in FY18. Adjusted operating margin for 2019 is expected to increase 70 bps to 11.5% from 10.8% in 2018.
Income from continuing operations is forecasted to increase from $109.7 million in 2018 to $118.9 and $131.7 million in 2019 and 2020, respectively. This growth in income from continuing operations results in Earnings per Share in 2018 of $1.31 and forecasted EPS of $1.46 and $1.61 in 2019 and 2020, respectively.
VALUATION AND RECOMMENDATION
We value HSC using a combination of multiples based on industry peer companies (P/E and EV/EBITDA multiples), blended with our Discounted Cash Flow (DCF) valuation to derive a fair value target price for the company.
HSC’s Industrial business is valued using a broad group of capital goods/industrial machinery peers. For the Rail segment, we use Wabtec Corp (NYSE: WAB) as the potential comparable company. We have also factored in contribution from the potential sale of the two Industrial businesses (IKG and PK). We have valued these businesses at ~$150 million at ~7.5x 2019 EBITDA (combined EBITDA of ~$20 million). The multiple is at a discount to the recent sale of Air-X at 12x given that IKG and PK have much lower margins.
Overall, we are valuing HSC using a 15% discount to the industry average P/E and EV/EBITDA multiples. Since HSC is a multi-year growth story based on aggressive expansion plans, we are applying these discounted multiples to our 2020 forecasted results. We then average the two price targets from the discounted 2020 P/E and EV/EBITDA multiples. Then, we discount that average target back to the present at our computed cost of capital. We weight this discounted multiple target to equal 50% of our price target. The average of these two multiple based targets is $34.02, which discounts back to the present value of $31.73.
We weight the other 50% of our target using our Discounted Cash Flow (DCF) model price. Our DCF model uses our forecasted free cash flow to the firm over the next one year and then grows EBIT at a 6% rate over years 2-8. We apply a weighted average cost of capital of 7.21% which is a combination of a 8.06% cost of equity and a 6.0% pre-tax cost of debt. Thus, our DCF produces a value of $32.61.
The combination of $31.73 at 50% and $32.61 at 50% results in a weighted average price target of $32.17 which we round up to $32.25.
The exhibit below summarizes our peer group multiples, while the DCF is included at the end of this report.
The Exhibit below shows stock price targets using various combinations of forward EPS and P/E multiples. Our EPS estimates for 2019 and 2020 are $1.46 and $1.61. The portion of the chart not shaded shows resulting stock price targets at various forward P/E multiples that are above the current price of $25.00 on May 31, 2019.
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Disclosure: I am/we are long HSC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.