Clean Harbors Goes Back To Its Roots In A Big Way

By Stephen D. Simpson, CFA | October 30, 2012 AAA

Clean Harbors (NYSE:CLH) is an interesting company. Built around hazardous waste collection and disposal, the company remains a leader when it comes to these services, but perhaps not as many investors are aware of how it has also built a large oil and gas services business (largely through acquisitions). At the end of October, however, the company took a big step back to its roots in announcing the acquisition of Safety-Kleen.

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The Deal
Clean Harbors announced that it had reached an agreement to acquire privately held Safety-Kleen for $1.25 billion in cash. This is not an especially surprising deal, as Clean Harbors had previously acquired a business from Safety-Kleen and the two companies were both competitors and collaborators in various markets, and this supposedly wasn't the first time Clean Harbors approached them with a deal.

What Clean Harbors Is Acquiring
In buying Safety-Kleen, Clean Harbors will be significantly expanding its capabilities in waste oil collection and treatment. Safety-Kleen collects about 200 million gallons of used oil per year, and should also expand Clean Harbors' abilities in re-refining waste oil and recycling solvents, not to mention its exposure to small-quantity waste generators.

This is a significant deal for Clean Harbors. Safety-Kleen generated about $1.3 billion in revenue last year (about two-thirds the total of Clean Harbors) and $161 million in EBITDA. At less than one times revenue and eight times EBITDA, this is not an expensive deal but Safety-Kleen's margins are lower than those of Clean Harbors. At the same time, there should be solid opportunities for operating synergies and cross-selling that would enhance the value and returns of the deal for Clean Harbors.

SEE: Analyzing An Acquisition Announcement

Should Be a Lower-Risk Deal
While U.S. markets were closed on Monday and Tuesday after the deal announcement, I would expect investors to generally approve of this deal. At a minimum, the similarities of the two businesses should greatly reduce the integration and execution risks for the deal.

Waste management is a difficult business for new entrants - it is generally difficult to get approval for new disposal facilities, and Clean Harbors faces only a limited number of rivals like Veolia (NYSE:VE), Waste Management (NYSE:WM) and US Ecology (Nasdaq:ECOL) in its hazardous waste businesses. The same is true for oil re-refining, and although a relatively small percentage of waste oil is presently recycled (less than 20%), higher crude prices and more stringent environmental regulation and enforcement should make Safety-Kleen's core operations more lucrative in the years to come.

The Bottom Line
Clean Harbors isn't getting Safety-Kleen for a song, but I think it's a good deal for the company. At a minimum, it should be a good compliment to the existing waste management and recycling operations at Clean Harbors and it offsets some of the risk and volatility of the company's growing energy services business.

The downside to Clean Harbors is that Wall Street already seems to expect quite a lot from the company. The company has shown some recent improvements in free cash flow generation, but the historical performance has been relatively erratic. So too with return on invested capital, which has generally been pretty solid, but not consistent.

SEE: 5 Must-Have Metrics For Value Investors

Prior to this deal, even high single-digit revenue growth (excluding M&A) and a doubling of the company's average free cash flow margin wasn't enough to produce a fair value as large as the current stock price, even with the stock at a 52-week low. While this deal should create value for Clean Harbors, investors buying today have to be aware that this company is going to have continue to grow at an above-average rate and significantly improve its free cash flow generation to outperform. I would give this company an above-average chance of achieving that level of performance, but it doesn't look like a value stock at this point.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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