stericycle (srcl) - waste management franchise at unassuming price

DISCLAIMER Copyright 2016 Intelligent Investors.co.uk. All rights reserved. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment.

Intelligent Investors.co.ukStericycle (SRCL)

Medical Waste Franchise at Unassuming Price

Investment Thesis:

Stericycle is the largest US regulated medical waste disposal company with

strong competitive position in an attractive and growing niche. Stericycle has

branched out into adjacent business services such as secure information

destruction markets and industrial waste disposal. Stericycle has historically

acted as an industry consolidator growing market share, cross selling adjacent

services, building up infrastructure and spreading the cost of running waste

disposal network over higher volumes thus lowering overall cost.

Recent share price drop due to number of profit warnings has created a

potentially attractive entry opportunity to aquire Stericycle shares as an

unassuming price.

Valuation: Stericycle is trading at $87 with fair value range of $90 based on 17.3 PE

multiple of adjusted 2017 EPS forecast ($5.20).

Business model Stericycle is a business-to-business services provider with a focus on regulated

and compliance solutions for healthcare, retail, and commercial businesses.

This includes the collection and processing of regulated and specialized waste

for disposal and the collection of personal and confidential information for

secure destruction, plus a variety of recall/return, communication, and

compliance services. Stericycle operates integrated operations and customer

service networks in the United States and 21 other countries. Stericycle

worldwide networks include a total of 253 processing facilities, 358 transfer

sites, and 137 other service facilities. Stericycle solutions for regulated or

specialty waste streams include: medical waste disposal, pharmaceutical waste

disposal, hazardous waste management, sustainability solutions for expired or

unused inventory, and secure information destruction of documents and e-

media.

SRCL builds on its core regulated

medical waste disposal franchise with

wide competitive advantages

underpinned by a dense network of

collection routes, processing facilities

and disposal locations, compliance with

Company Research

USA

Industry – Waste Management

3 Year Opinion Defensive

Competitive Adv. Wide

Fair Value Potential $90.00

Price $86.77

Consider Buying at $87.00

Date 13 August 2016

Market Data

52 Week Range 81.99-151.57

Market Cap. $7.39bln

Shares Outstanding 84.9 mln

Volatility Medium

Balance Sheet Data

Shareholder equity $2.73bln

Price/Book Value 2.65

Net Debt/(Cash) $3.2bln

Debt/EBITDA 3.3x

Forecast Earnings

Potential price appreciation 3%

Dividend Yield/Share rep. 0.0%

EPS / PE Cons.

Period EPS PE

Dec 2015 $4.40 19.7 Dec 2016 $4.69 18.6 Dec 2017 $5.20 16.7 Dec 2018 $5.88 14.8

5 Year Share Price Chart




complex regulatory permits regime, long-term customer relationships characterised by recuring revenues

for no hassle bundled range of disposal service and cost advantages stemming from network

effects/efficient scale in the markets served (i.e. Stericycle displays utility type of economic model).

SRCL is operating in highly fragment markets with many small providers and many small quantity

customers, and is thus able to deploy its competitive strenghts to consolidate competitors, gain market

share and drive the cost down. SCRL business model has characteristics of utility type franchise with

economies of scale at work but unlike utility it isn’t subject to price regulation.

SCRL diversified into industrial waste disposal and secure information destruction markets which display

similar economic characterics of economies of scale, complex regulation and network efforts. However,

these adjacent markets are more volatile, because fixed costs of operating disposal facilities are not

matched by predictable recurring revenue that core regulated medical waste disposal franchise offers,

leading to fluctuating profits.

Focus on the Small Customer with Recurring Service Need

Stericycle business strategy recognizes that smaller businesses have an even greater need for support with

compliance matters since they tend to lack the specialization of staff resources that is found among larger

businesses and hospitals. With a small business, regulatory and compliance matters are often managed by

a business owner, office manager, or facility supervisor who manage multiple functions for the

organization and often lack the time and resources to properly investigate and comply with a wide range of

regulations that may impact their operation. In response to this unmet need of small businesses, Stericycle

developed comprehensive, no-hassle compliance programs which feature scheduled service at low, flat

monthly fees. This business fundamental has guided Stericycle as the company has expanded into

additional service offerings including hazardous or pharmaceutical waste management, communication

services, and secure information destruction.

Organic Growth

As a leading provider in regulated and compliance solutions, Stericycle continues to focus on enhancing our

service offerings and platforms. Stericycle has developed a strong and loyal customer base, with a revenue

retention rate exceeding 90%, and has been able to leverage these customer relationships to provide

additional services. Allocation of sales resources has and will continue to focus on driving incremental

organic growth from cross selling and upselling various services in our portfolio.

Growth through Acquisition

The various regulated waste and compliance services that Stericycle provides tend to be in highly

fragmented industries. Stericycle has proved that acquisitions are a rapid and efficient way to scale

operations, build critical customer density for transportation and treatment operations, and enter

new markets or geographies, as well as an opportunity to introduce our additional services to the




acquired customers. In early history, acquisitions were a key strategy to building customer base and route

density in the United States. Over the company’s history, Stericycle has completed 435 acquisitions, with

230 in the United States and 205 internationally. During 2015, Stericycle completed 43 acquisitions.

Company expects to continue the acquisition strategy in North America and internationally, remaining

focused on small, highly accretive, tuck in acquisitions that broaden various service capabilities while

creating value for our shareholders.

SRCL operated in highly regulated medical waste

market which is subject to numerous regulations. In

many countries there are multiple regulatory agencies

at the local and national level that affect the services.

This statutory and regulatory framework imposes a

variety of compliance requirements, including

requirements to obtain and maintain government

permits. These permits grant SRCL the authority, among

other things:

• to construct and operate collection, transfer and

processing facilities;

• to transport regulated waste within and between relevant jurisdictions; and

• to handle particular regulated substances.

The permits must be periodically renewed and are subject to modification or revocation by the

issuing authority.

Strict enforcement of laws and regulations relating to regulated waste collection and treatment and the

proper handling and protection of personal and confidential information by governmental authorities can

have a positive effect on SRCL business. These laws and regulations increase the demand for SRCL services.

Relaxation of enforcement or other changes in governmental regulation of regulated waste and personal

and confidential information could increase the number of competitors SRCL faces or reduce the need for

its services.

Competition

The industries and markets in which SRCL operates are highly competitive, and barriers to entry are low.

SRCL competitors consist of many different types of service providers, including national, regional and local

companies. In the regulated waste and secure information destruction industries, another major source of

competition is on-site treatment. For regulated medical waste, some large-quantity generators, particularly

hospitals may choose an onsite autoclave or other treatment process. For secure information destruction,

many businesses may choose to use small, on-site shredders for their documents. Similarly, customers

could handle recalls or communication solutions internally.




In addition, SRCL faces potential competition from businesses that are attempting to commercialize a wide

range of technologies that directly or indirectly reduce the need for regulated medical waste, hazardous

waste or secure information destruction services.

Competitive position Stericycle enjoys high regulatory barriers to entry including government regulation, high cost / hard-to-

obtain permits to build extensive waste handling infrastructure, highly fragment waste mgt markets,

relationships with existing client relationships based on bundled offering/multiple services, and economies

of scale confered by market share leadership position. Stericycle has the wide competitive moat due to it’s

leading position and scale in medical waste disposal that was built over years organically and by

acquisitions. Stericycle has built a network of waste management collection routes, waste handling and

disposal facilities. Such network is hard to establish by

a new player with same level of efficiency and scale,

thus limiting list of potential contractors that clients

can bid out the job to and limiting clients’ bargaining

power. Stericycle service offering based on bundled

no-hassle services encourages strong customer

retention at over 90% and limits pricing incentives for

customers to switch to another provider. Stericycle

makes no secret of its aspirations to cross sell

additional services into client offering including

management of sharp items, prescription drugs

disposal, information destruction, communication

solutions, compliance and others.

Market Size and Growth Potential Stericycle provides a wide range of services across multiple market segments and industries. Company

believes that in 2016, the size of the global market for the services, in the geographies company currently

operates in, is approximately $33 billion. Industry growth is driven by a number of factors.

These factors include:

Aging of Population: The average age of the

population in the countries where Stericycle

operates is rising. As people age, they typically

require more medical attention and a wider

variety of tests, procedures and medications,

leading to an increase in the quantity of

regulated medical waste, hazardous waste,

and pharmaceutical waste, as well as an




increase in confidential healthcare records requiring secure destruction.

Pressure to Reduce Healthcare Costs:The healthcare industry is under pressure to reduce costs.

Stericycle services can help healthcare providers to reduce their handling and compliance costs

and to reduce their potential liability for employee exposure to bloodborne pathogens and other

infectious agents. In addition, hospital institutions and smaller healthcare practices continue to

outsource compliance, communication, and secure information destruction services.

Enforcement of Regulations: Enforcement of regulations relating to the management of regulated

waste and protected information is increasing. Penalties for violations can be costly as well as high

profile thereby impacting a business’ overall reputation. Greater enforcement combined with

higher penalties results in more compliance by waste generators and a corresponding increase in

potential customers.

Safety and Security Regulation: Many businesses that are not currently using third party regulated

waste management or secure information destruction services are unaware either of the need for

proper training of employees or of the regulatory requirements regarding the handling of such

materials.

Increased Business Focus on Sustainability: Businesses large and small continue to realize that

focus on sustainability is now a business essential in order to operate efficiently and meet the

increasing demands of customers for environmental responsibility. Such pressures are driving

proper disposal of pharmaceuticals, recycling efforts, creative disposal efforts for unused inventory

and shred-all policies for paper.

Shift to Off-Site Healthcare Treatment: The patient care in the U.S. is continuing to shift from

institutional higher-cost acute-care settings to less expensive, smaller, off-site treatment

alternatives, with a resulting increase in the number of healthcare providers generating regulated

medical waste, pharmaceutical waste, and protected health information requiring secure

destruction.

Regulation of Privacy and Information Security and Concerns over Data Breaches: Continued

development and growth of the secure information destruction industry have been driven, in part,

by compliance with government regulations in respect of privacy and information security.

International Market Development: The development of regulated medical waste regulations,

hazardous waste regulations, and secure information destruction regulations in certain

international markets are at an early stage of development relative to North American and certain

European Markets. As emerging markets continue to advance their healthcare practices,

environmental controls, and their data privacy regulations, further demand is expected.

Key risks to the thesis - Consolidation of small quantity players by large healthcare providers and related pricing pressure on

core services

- Lack of quality acquisition targets available at reasonable prices

- Volatility of demand in industrial waste segments in line with general economic environment




- Continued losses/ low profitability in international markets

- Large debt load of circa $3bln USD

Valuation Scenario analysis

Scenario Price target Triggers Bull case $105

Higher international growth, shift towards higher margin small quantity customer

Base case $90

Steady low single digit growth, maintain profitability in the core business, realize synergies and growth from concluded aquisitions

Bear case $75

Further profitability deterioration in core medical waste management business due to pricing pressures, industrial waste profitability deterioration due to economic cycle

Risk profile SCRL has relatively low business risk profile, however high PE ratio makes share price vulnerable to even

the smallest earnings expectation miss. SCRL has a wide competitive advantage in an attractive market

niche and we expect that over time the favourable economics will re-assert themselves and business will

get back to sustainable growth trajectory

Author’s opinion Stericycle is a unique franchise in a growing market niche with strong competitive position and plenty of

growth ahead. Stericycle share price has declined sufficiently to warrant modestly adding to SRCL position

starting from $87 level at no more than 1/3 of the target purchase value and execute any additional

purchases at $7 intervals i.e. at $80 and $73 in the event of further decline.

$105.00 (+20%)

$75.00 (-14%)

$90.00 (+3%)




We put our money where our mouth is as the author(s) of the report may presently or in the future hold

a common stock investment in the securities mentioned in this report.

This report has been prepared by Intelligent Investors.co.uk.

DISCLAIMER

Copyright 2016 Intelligent Investors.co.uk. All rights reserved. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable; however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Intelligent Investors.co.uk at the time of publication. The author(s) of the report hold a common stock investment in the securities mentioned in this report. The research in this document is not intended for retail investors. This is not a solicitation or inducement to buy, sell, subscribe, or underwrite securities or units. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment. Intelligent Investors.co.uk is NOT regulated by the FSA. A marketing communication under FSA Rules, this document has NOT been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance.

stericycle (srcl) - waste management franchise at unassuming price

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