Harsco Could Be Troughing

By Stephen D. Simpson, CFA | June 27, 2012 AAA

These have been challenging times for industrial conglomerate Harsco (NYSE:HSC). Weak demand for commercial construction and weak funding for infrastructure projects has hurt the company's infrastructure business, while a weak market for European steelmakers has likewise hurt the mill services business. Calling a bottom in non-residential construction or steel is a fool's errand, but odds favor these markets getting better over the next year or two and a new CEO could reverse a disappointing record regarding cash flow generation and asset efficiency.

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Not Much Joy at Present
Harsco derives a sizable percentage of its revenue from infrastructure and construction products like scaffolding and concrete forms, as well as services provided to steelmakers (like maintenance and scrap management). What's more, significant amounts of business in those two segments come from Western Europe. As a result, the fact that Harsco's financial performance is unimpressive today is about as surprising as Tuesday following Monday.

SEE: Why Europe Has The Cheapest Airfare

For the first quarter, for instance, core revenue fell about 2%, with the aforementioned infrastructure and mill services businesses down 3% each. While the company's rail and industrial businesses are stronger (and much more heavily weighted to North America), the company is still in the red at both the operating income and OCF lines. Elsewhere, sell-side EPS estimates for 2012 and 2013 have dropped about 10-15% in the last three months.

Potential Reasons for Optimism
Many of Harsco's businesses are inherently cyclical, and that's not a recent development. So what is weak today should, in time, improve. More specifically, the company has continued to sign contracts and contract renewals in the mill business, and client companies like ArcelorMittal (NYSE:MT) aren't giving up on the idea that next year could be better.

SEE: The Ups And Downs Of Investing In Cyclical Stocks

That said, Harsco seems to be lagging rivals like TMS (NYSE:TMS) and Sims (NYSE:SMS), and I suspect a lot of that comes from the greater reliance on Western Europe. Management is active here too, though, and restructuring efforts should see the company exit several less attractive countries and operate with a more keen focus on profitability.

The company is also likely close to an announcement regarding a new permanent CEO. While former CEO Fazzolari resigned, comments from both the company and analysts suggest it was a "jump...or we push" sort of move. While Fazzolari is not solely responsible for the inefficiencies and underwhelming results at Harsco, he was not moving very quickly or dynamically to fix them. I hope that Harsco finds a new leader who is more willing to focus the company around optimal cash flow generation and returns on invested capital, and be more willing to exit businesses that don't measure up.

SEE: Management Strategies From A Top CEO

The Bottom Line
It doesn't seem like much of an exaggeration to say that investors buying Harsco today are buying a troubled and historically unimpressive company on the basis of what the company could be, with the combination of better management and healthier end markets. To that end, these shares do not seem very expensive, and even just a restoration of the Street's confidence (and the resulting higher multiples) in the name would deliver some solid capital gains.

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

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