Imperial Capital
Within solid waste, we generally expect third-quarter earnings
to be consistent with a steadily improving U.S. economy and
rational market conditions.
After starting the year slowly with waste stocks down 2.4% and
the Standard & Poor's 500 up 1.3% in the first quarter of 2014,
stocks rebounded in the second quarter. Waste stocks posted a 10.6%
average increase versus the S&P 500 up 4.7%, though relative
performance softened in the third quarter, as the group (down 3.7%,
on average) lagged the S&P 500 by nearly 430 basis points and
the S&P 500 up 0.6%, reflecting particular weakness in
small-cap and/or energy-related names (Casella Waste Systems
(ticker: CWST), and Clean Harbors ( CLH)). Conversely, larger and
less energy-sensitive names (Waste Management ( WM), Republic
Services ( RSG) and Covanta Holding ( CVA)) outperformed in the
most recent period, perhaps reflecting their resilient nature.
Overall, we expect positive solid-waste volumes (with the
exception of Waste Management), led by industrial, supplemented by
additional signs of improvement in commercial, and with residential
continuing to lag. Price growth should similarly be modest, but
positive (up 1%-3%), with industry conditions remaining rational
(Northeast disposal remains a possible exception), offset by low
consumer price index-linked pricing. Declining diesel fuel costs
(down 6% since the end of second-quarter 2014, as of Oct. 13) could
lift earnings on the margin, though continued weakness in recycled
fiber prices, down 3% since the end of the second quarter, as of
Oct. 14 could offset any such benefit.
In specialty waste, we expect continued strength in U.S.
industrial and energy waste volumes in the third quarter, but
remain watchful for signs of a slowdown in the exploration and
production activity, given the recent pullback in crude oil, with a
particular focus on several oil-rich basins in the U.S., as well as
the Canadian oil sands. We also note that the recent slide in the
Canadian dollar (89.3 U.S. cents, versus 93.7 U.S. cents in the
second quarter) could impact companies with meaningful exposure to
Canada (we are lowering our estimates accordingly for Clean
Harbors, as well as Progressive Waste Solutions ( BIN)).
Furthermore, we note that recent declines in base oil prices
could weigh on used oil recyclers such as Clean Harbors and Vertex
Energy ( VTNR) (we are trimming our estimates for both companies,
as well as Nuverra Environmental Solutions ( NES)).
We are interested in hearing what Waste Management will do with
its proceeds from the Wheelabrator divestiture. We are interested
in seeing if Republic Services' financial priorities will change
under new Chief Financial Officer Chuck Serianni (we doubt it). We
are interested in hearing if Waste Connections ( WCN) will favor
mergers and acquisitions, buybacks or dividends in the near-term.
We are interested in seeing how much margin improvement Progressive
Waste will generate under its new cost reduction initiatives. We
are interested in any update regarding Clean Harbors' strategic
review and/or capital deployment preferences. We are interested in
any news regarding Vertex's pending (or perhaps new) acquisitions,
as well as an update on US Ecology's ( ECOL) integration of the
Environmental Quality Company acquisition and its event project
pipeline. Lastly, we are interested to see if Casella will provide
better line-of-sight to future improvements in margins and free
cash flow.
The environmental-services stocks are trading at average
2014-2015 estimated enterprise value to earnings before interest,
taxes, depreciation and amortization [Ebitda] multiples of 10.1
times and 8.4 times, following a period of relatively healthy
performance, with specialty names generally trading at higher
multiples than most solid waste names, as is customary.
Our top waste picks heading into the third-quarter earnings
season are Covanta and Waste Connections, based on our confidence
in potential upside to earnings expectations. We think Clean
Harbors and Nuverra pose potential risk heading into earnings, and
we are lowering our estimates for both companies.
-- Scott Levine
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