Matthew Young: Narrow-moat medical-waste management leader Stericycle has faced several waves of negative investor sentiment over the past several years. Some of that's been warranted, but not all of it.
Much of the selling pressure has been driven by the emergence of painful pricing concessions in 2016 among high margin small-quantity waste-generating accounts, coupled with a string of guidance shortfalls and a lackluster performance in the noncore industrial hazardous waste division.
SQ-customer pricing rollbacks (a key overhang on the stock) 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, our analysis suggests Stericycle's market price is at the point where its baking in overly pessimistic midcycle revenue and margin assumptions. By our estimation, the market is partly assuming the company will grapple with material long-term pricing headwinds that would relegate its core med-waste division to flattish midcycle organic revenue growth.
Execution risk does add uncertainty to the equation here--especially given the firm's multiyear ERP-system rollout, and we would note that any related shortfalls in the quarters ahead could weigh even more heavily on the stock price.
However, customer pricing headwinds of the current magnitude should abate in 2019 as the firm cycles through SQ contract renewals and as negative publicity from the recently settled SQ class-action lawsuit dissipates.
We think Stericycle's flagship med-waste division is capable of rekindling low- to mid-single-digit midcycle organic revenue growth, with consolidated EBITDA margins materially improving under a stable pricing backdrop. That's a far cry from its historical high-single digit growth trajectory but probably better than the performance baked into the current market price.
Overall, the shares trade at a healthy 37% discount to our fair value estimate, presenting a buying opportunity for patient, long-term-minded value investors capable of stomaching heightened volatility in the year ahead.