Pricing Reset Needles Stericycle's Growth, but Shares Undervalued
Small-quantity rollbacks won't weigh on the stock indefinitely.
Narrow-moat medical waste industry leader Stericycle (SRCL) has grappled with negative investor sentiment, some of it warranted, for several years. This was driven in large part by the emergence of painful contract concessions in its premium-priced small-quantity, or SQ, waste-generating account base, coupled with guidance shortfalls and lackluster performance in the noncore industrial hazardous waste unit. Importantly, SQ pricing rollbacks are the fruit of a decade of consolidation of small physician practices into large hospital groups with stronger buying power, as well as pushback from existing small independent healthcare customers looking to slash costs against an inflationary backdrop. However, we believe Stericycle's market price is baking in overly pessimistic midcycle revenue and profitability assumptions. Execution risk adds uncertainty to the equation, but pricing headwinds of the current magnitude are probably not permanent, and we expect the flagship regulated med-waste division to gradually rekindle low- to mid-single-digit organic revenue growth. The shares trade more than 40% below our $83 fair value estimate, which we think is a compelling buying opportunity for patient, long-term-minded value investors capable of stomaching heightened volatility in the year ahead.
Stericycle's shares reached a peak near $150 in October 2015 before heading into a multiyear decline, with several big steps down along the way. Selling pressure was initially driven by earnings misses in late 2015 and early 2016 that were in part linked to two large, expensive acquisitions that added complexity to the organization and stretched its resources. Not long after Stericycle bought it in 2014, PSC Environmental (industrial hazardous waste; now the manufacturing and industrial services, or M&I, segment) ran into a pullback in U.S. industrial activity and headwinds among energy end-market customers, and the deal arguably took the company into a less core, more competitive marketplace. Also, although the document destruction services of Shred-it (acquired in 2016) are now enjoying healthy organic growth, the integration faced a rocky start. More important was the emergence of a painful contract repricing phase among the company's premium priced small-quantity waste generator accounts. By mid-2016, management began acknowledging the issue as formerly robust organic growth in the flagship regulated medical waste and compliance services division began to deteriorate. Further guidance shortfalls and concerns about the duration of SQ pricing concessions have continued to weigh on sentiment.
Matthew Young does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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