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This isn’t an unprofitable speculative venture capital-backed company. This isn’t an overhyped popular billion-dollar company, either. This small-cap stock is a profitable company with strong fundamentals and growth potential in a boring industry.
We are talking about Heritage-Crystal Clean, Inc. (NASDAQ:HCCI). HCCI’s stock has doubled since late 2020 and is currently standing at approximately $28 per share, so we will re-evaluate it from a risk-reward perspective.
Heritage-Crystal Clean – A Brief Overview
HCCI operates its business through the Environmental Services and Oil Business segments. The Environmental Services segment consists of full-service parts cleaning, containerized waste management, wastewater vacuum, antifreeze, and field services. These services allow HCCI’s customers to outsource their handling and disposal of parts-cleaning solvents as well as other hazardous and non-hazardous waste.
The Oil Business segment consists of used oil collection activities, re-refining activities, oil filter removal and disposal services, and the sale of recycled fuel oil. On that front, HCCI operates a used oil re-refinery with an annual nameplate output of lubricating base oil which has a capacity of 75 million gallons of used oil feedstock. The company recycles used oil into high quality lubricant base oil and other products, and it’s a supplier to firms that produce and market finished lubricants.
As of January 1, 2022, HCCI operated 91 branches that vary in size and serve customer locations in the vast majority of the United States, the District of Columbia, and parts of Ontario, Canada. It’s also noteworthy that HCCI ranks high in its industry, as quoted below (emphasis added):
We believe that we are the second largest provider of full-service parts cleaning services and used oil collection services in the U.S., the second largest producer of remanufactured antifreeze, and a leading provider of containerized waste services to small and medium sized customers.
and (emphasis added):
We have the second largest used oil re-refinery, by capacity, in North America. We believe that our largest competitor, Safety-Kleen, (a wholly-owned subsidiary of Clean Harbors, Inc.), currently controls a majority of the used oil re-refining capacity in North America.
HCCI Has Got Consistent Profitability And Rock-Solid Balance Sheet
Debt-free cash-rich HCCI entered the economic downturn in 2020 with a strong balance sheet and a net cash position, which allowed it to emerge unscathed from this challenging period. However, it was not immune to the negative impact of the COVID-19 pandemic.
Specifically, revenue and net income declined 8.7% and 35%, respectively, compared to 2019. Fortunately, 2020 full-year net income was favorably impacted by a $6.5 million reversal of an $11 million class action lawsuit charge taken in Q4 2019, so net income in 2020 ended up being $11.9 million.
However, the company managed to battle exceptionally high cost inflation in various parts of its business, returning to growth mode in 2021. It announced strong top line and bottom line YOY growth a few days ago, as illustrated below:
| Fiscal Year | |||||||||||||||||||||||||||||||||||
| (In Thousands) | |||||||||||||||||||||||||||||||||||
| 2021 | 2020 | 2019 | 2018 | 2017 | |||||||||||||||||||||||||||||||
| STATEMENTS OF OPERATIONS DATA | |||||||||||||||||||||||||||||||||||
| Revenues | |||||||||||||||||||||||||||||||||||
| Service revenues | $ | 262,863 | $ | 245,474 | $ | 250,491 | $ | 250,262 | $ | 233,999 | |||||||||||||||||||||||||
| Product revenues | 227,737 | 136,178 | 171,273 | 159,921 | 131,958 | ||||||||||||||||||||||||||||||
| Rental income | 24,734 | 24,299 | 22,663 | — | — | ||||||||||||||||||||||||||||||
| Total revenues | $ | 515,334 | $ | 405,951 | $ | 444,427 | $ | 410,183 | $ | 365,957 | |||||||||||||||||||||||||
| Operating Expenses | |||||||||||||||||||||||||||||||||||
| Operating costs | 352,796 | 321,648 | $ | 349,603 | $ | 323,165 | $ | 276,102 | |||||||||||||||||||||||||||
| Selling, general, and administrative expenses | 56,987 | 47,091 | 50,224 | 47,714 | 47,401 | ||||||||||||||||||||||||||||||
| Depreciation and amortization | 23,542 | 24,563 | 18,249 | 16,157 | 17,967 | ||||||||||||||||||||||||||||||
| Other (income) expense – net | (988) | (5,365) | 13,490 | 1,606 | (10,940) | ||||||||||||||||||||||||||||||
| Operating income | 82,997 | 18,014 | 12,861 | 21,541 | 35,427 | ||||||||||||||||||||||||||||||
| Interest expense – net | 933 | 1,252 | 869 | 1,052 | 1,094 | ||||||||||||||||||||||||||||||
| Income before income taxes | $ | 82,064 | $ | 16,762 | $ | 11,992 | $ | 20,489 | $ | 34,333 | |||||||||||||||||||||||||
| Provision for income taxes | 21,116 | 4,825 | 3,243 | 5,451 | 5,923 | ||||||||||||||||||||||||||||||
| Net income | 60,948 | 11,937 | 8,749 | 15,038 | 28,410 | ||||||||||||||||||||||||||||||
As shown above, the profit margin expansion in 2021 can’t go unnoticed. Specifically, operating margin for 2021 was 28% compared to 15.8% operating margin in fiscal 2020. The increase in margin was mainly due to an increase in the spread between the netback (sales price net of freight impact) on its base oil sales and the price paid/charged to its customers for the removal of their used oil along with an increase in sales volume in its Environmental Services segment. Corporate SG&A expense for fiscal 2021 stayed flat at 12.1% of revenue, compared to 12.7% of revenue in fiscal 2020.
This recovery in 2021 was the result of both organic and inorganic growth. Actually, the key factors that contributed to this excellent operational performance were the recovery from the negative impacts of the COVID-19 pandemic in the company’s segments, the big improvement in base oil pricing in the Oil Business segment, and the acquisitions completed in 2021.
Specifically, HCCI acquired three smaller players for $45.5 million in 2021, as quoted below:
On August 24, 2021, Heritage-Crystal Clean completed the acquisition of certain assets of Bakersfield Transfer, Inc., and Cole’s Services, Inc., which processed, stored, and disposed of hazardous waste within the state of California. On September 13, 2021, we completed the acquisition of Raider Environmental Services of Florida, Inc., which has expanded our network of wastewater processing, oil collection and non-hazardous waste solidification to better serve our customers in Florida and throughout the Southern United States. On September 27, 2021, we completed the acquisition of Source Environmental, Inc., which increases the Company’s penetration in the hazardous and non-hazardous waste business in several markets in the western U.S. This transaction also provides us the opportunity to internalize the performance of certain field service activities in the western U.S.
Most of the revenue (62%) in 2021 came from the Environmental Services segment, while revenue in the Oil Business segment accounted for 38% of the total revenue, as illustrated below.
| For the Fiscal Years Ended, | Increase | ||||||||||||||||||||||||||||
| (thousands) | January 1, 2022 | January 2, 2021 | $ | % | |||||||||||||||||||||||||
| Revenues: | |||||||||||||||||||||||||||||
| Environmental Services | $ | 318,167 | $ | 290,592 | $ | 27,575 | 9.5 | % | |||||||||||||||||||||
| Oil Business | 197,167 | 115,359 | 81,808 | 70.9 | % | ||||||||||||||||||||||||
| Total | $ | 515,334 | $ | 405,951 | $ | 109,383 | 26.9 | % | |||||||||||||||||||||
It’s also worth noting that HCCI does not have high customer concentration, so it’s not heavily dependent on a handful of customers. Instead, HCCI has a large and highly diverse customer base that is primarily composed of small companies in the vehicle repair and manufacturing industries, as quoted below:
Our focus on small and mid-sized businesses has enabled us to attract a variety of customers engaged in a wide range of industrial businesses (such as manufacturing, transportation and distribution) and vehicle service. This diversification helps insulate us from disruption caused by the possible loss of a single large account. Our customer base consists of over 95,000 active customer locations. In fiscal 2021, our largest single customer in our Environmental Services segment represented 0.5% of our consolidated revenues, and our largest ten customers represented approximately 3.4% of our consolidated revenues. In the Oil Business segment, for fiscal 2021, our largest single customer accounted for 5.8% of our consolidated revenues, and our largest ten customers represented 24.8% of our consolidated revenue.
Last but not least, from a cash flow standpoint, HCCI generated positive operating cash flow and positive free cash flow for another year in a row, as illustrated below.
| For the Fiscal Years Ended, | ||||||||||||||
| (thousands) | January 1,2022 | January 2,2021 | ||||||||||||
| Net cash provided by (used in): | ||||||||||||||
| Operating activities | $ | 91,047 | $ | 44,769 | ||||||||||
| Investing activities | (67,854) | (32,477) | ||||||||||||
| Financing activities | (34,499) | (5,411) | ||||||||||||
| Net (decrease) increase in cash and cash equivalents | $ | (11,306) | $ | 6,881 | ||||||||||
Outlook
Outlook is positive with growth being organic and inorganic, despite tough comps ahead.
Specifically, when it comes to organic growth, HCCI expects to announce top line YoY growth in 2022, based on the latest CC below (emphasis added):
Now I would like to look forward to discuss our outlook for the future. In our Environmental Services segment, we experienced a great start to our first quarter from a revenue perspective. Despite the fact that we experienced more confirming cases of COVID-19 in January 2022 than any previous month during the pandemic, we have still managed to generate double-digit revenue growth on a year-over-year basis for the first several weeks of the first quarter. Assuming the overall US economy remained steady, we expect to achieve low double-digit revenue growth during the first half of 2022, with slower growth in the second half of the year, as we face tougher comparable results from 2021.
From an operating margin percentage standpoint, we expect to continue to battle higher costs during the first half of the year. While our fourth quarter price increase in the Environmental Services segment was successful, we did not anticipate that the factors driving higher costs in various parts of our business were not only continued, but worsened throughout the fourth quarter and end of the first quarter.
In response to these higher costs, we implemented additional price increases during the first quarter. Since some of these increases were not implemented until the end of February, we expect operating margin to be in a low 20% range during the first quarter, with gradual improvement throughout the remainder of the year. We expect to exit fiscal 2022 as segment operating margin at or close to 27% provided inflationary condition stabilize as expected.
and:
From an Oil Business segment perspective, we’re happy with the start of 2022. Demand from our customers remains steady and we expect it to remain consistent provided additive supply improves as we move into the busier spring and summer seasons. While the higher crude oil prices will continue to put pressure on our pay for oil, we believe the combination of factors I just discussed will allow us to generate an operating margin in the mid-20% range during the first half of 2022.
When it comes to inorganic growth, HCCI will most likely announce new acquisitions in the next quarters, as quoted below:
I think most of our growth will come from acquisitions. We don’t have a lot of plans to open organic branches unless it’s around the tuck-in acquisition. And I think we’ve talked about that the last couple of quarters, we prefer to open up in new markets with a tuck-in acquisition and bolt-on our service lines. It’s just much easier in this environment because of the difficulty in recruiting employees, staffing and roll trucks, I mean, it’s a tough labor market. So we’re going to go to the tuck-in acquisition route and we’ll expand that way.
HCCI Stock Valuation
Based on the outlook above, we estimate that revenue and adjusted EBITDA in 2022 will be about $550 million and $115 million, respectively, which excludes any acquisitions.
Meanwhile, with zero debt and $56 million in cash, HCCI’s Enterprise Value currently is about $630 million.
Therefore, EV-to-2022 Revenue and EV-to-2022 adj. EBITDA are about 1.1 times and 5.5 times, respectively, the current price of $28 per share. Obviously, HCCI is not expensive and still has upside potential from today’s price for investors with an investment horizon of 2-5 years.
However, HCCI was absurdly cheap in late 2020 when it traded well below $20 per share, so we believe that the easy money has been made.
Heritage-Crystal Stock Insider Ownership
We always check the insider ownership before buying it for our portfolio and before advising our subscribers to buy it too. That said, insiders (10 persons) own approximately 7.5% of the stock, as illustrated below.
| Name | Number of Shares Beneficially Owned | Percentage of Outstanding Common Stock | ||||||||||||
| Directors: | ||||||||||||||
|
Fred Fehsenfeld, Jr. |
1,046,800 | 4.3% | ||||||||||||
| Bruce Bruckmann | 124,609 | * | ||||||||||||
| Charles Schalliol | 54,515 | * | ||||||||||||
| Robert Willmschen, Jr. | 51,828 | * | ||||||||||||
|
Jim Schumacher |
27,273 | * | ||||||||||||
| Carmine Falcone | 2,124 | * | ||||||||||||
| Anthony Chase | 1,641 | * | ||||||||||||
| Beneficial Owners owning more than 5% of common stock (other than directors and named executive officers): | ||||||||||||||
|
The Heritage Group |
5,005,444 | 20.7% | ||||||||||||
|
Fehsenfeld Family Trusts |
1,540,959 | 6.4% | ||||||||||||
| Named Executive Officers: | ||||||||||||||
|
Brian Recatto |
670,505 | 2.8% | ||||||||||||
| Mark DeVita | 89,925 | * | ||||||||||||
| Ellie Bruce | 84,636 | * | ||||||||||||
|
All directors and executive officers as a group (10 persons) |
2,153,856 | |||||||||||||
____________
* Less than 1%
This 7.5% stake isn’t low, but it’s not high either. As also illustrated above, The Heritage Group and Fehsenfeld Family Trusts own 20.7% and 6.4%, respectively. Given that these shares are owned by family members, we consider that Mr. Fehsenfeld is motivated to make HCCI succeed, although he disclaims beneficial ownership of these shares, as quoted below (emphasis added):
Mr. Fehsenfeld disclaims beneficial ownership of the shares of common stock owned by these family members except to the extent of his pecuniary interest therein. In addition, Mr. Fehsenfeld serves as one of nine trustees who together are empowered to act on behalf of The Heritage Group. Mr. Fehsenfeld disclaims beneficial ownership of the shares of common stock owned by The Heritage Group listed in the table above, except to the extent of his pecuniary interest therein, and none of the shares held by The Heritage Group are included in the shares listed in the table above as being beneficially owned by Mr. Fehsenfeld. In addition, the number of shares beneficially owned does not include the 1,540,959 shares of common stock held by the Fehsenfeld Family Trusts, for which Mr. Fehsenfeld is a co-trustee.
In other words, we could say that insider ownership is almost 35%, including the shares held by The Heritage Group and Fehsenfeld Family Trusts. This means that insider ownership is high, so insiders’ interests are aligned with shareholders’.
However, institutional ownership is low at just 15.2%, as illustrated below.
| Name | Number of Shares Beneficially Owned | Percentage of Outstanding Common Stock | ||||||||||||
| Beneficial Owners owning more than 5% of common stock (other than directors and named executive officers): | ||||||||||||||
|
ArrowMark Colorado Holdings |
2,129,995 | 8.8% | ||||||||||||
|
T. Rowe Price Associates, INC. |
1,552,185 | 6.4% | ||||||||||||
Therefore, the CEO needs to consider presenting the company to funds and institutions in the next months in an effort to tell the audience a compelling story about HCCI and its potential to grow and make profits in the future.
Risks
From an operational standpoint, we believe that existing shareholders and potential buyers should monitor the following risks very vigilantly:
1) Commodity risk: HCCI benefited from the significant increase in oil prices in 2021, but we believe that if oil prices do not exceed $100 in the next quarters, it will be short-lived.
In other words, we forecast that the trend in oil prices will gradually turn down, so oil prices will gradually drop and/or go sideways in 2022-2023, which will weigh on the company’s (Oil Business segment) netback and profitability. To say it differently, we forecast that the company’s margin expansion in 2021 is not durable and will not last through 2023.
2) Competition: The competition is expected to remain intense, which could likely prevent HCCI from successfully implementing its growth strategy, as quoted below:
We face intense competition in the industrial and hazardous waste services industries and from other used oil re-refiners: The markets for parts cleaning, containerized waste management, used oil collection, wastewater vacuum services, antifreeze recycling, and field services are intensely competitive. Numerous small companies provide these services at a regional or local level and may be able to compete with lower overhead and operating costs. In addition, Safety-Kleen, a wholly-owned subsidiary of Clean Harbors, Inc. and our largest competitor, has held substantial market share in the full-service parts cleaning industry for the last five decades and has developed a material market share in used oil services, including used oil collection, vacuum services and containerized waste management. Safety-Kleen has greater financial and other resources and greater name recognition than us. Our business growth, financial performance, and prospects may be adversely affected if we cannot effectively compete against these competitors, or if any of our competitors develop products or services superior to those offered by us. We could lose a material number of customers if Safety-Kleen or other competitors materially lower their prices, improve service quality, or develop more competitive product and service offerings.
In addition, companies involved in the waste management industry, including waste hauling, separation, recovery, and recycling, may have the expertise, access to customers, and financial resources that would encourage them to develop and market services and products competitive with those offered by us. We also face competition from alternative services that provide similar benefits to our customers as those provided by us. In addition, new technology regarding the treatment and recycling of used solvent may lead to functionally equivalent or superior products or services becoming available, which may decrease the demand for our services and products or cause our products and services to become obsolete.
In the past many of our competitors announced plans to enter the used oil re-refining or base oil production business or expand their existing used oil re-refining or base oil producing businesses by adding additional capacity. If the price of crude oil and the price for re-refined oil products increases, competitors may again consider these plans. The additional competition may make it harder for us to sell our re-refined base lube oil. In addition, extra competition in the collection of used oil feedstock may increase our cost to collect used oil or prevent us from collecting enough feedstock to operate the used oil re-refinery at capacity.
3) Acquisitions: As quoted above, HCCI will pursue acquisition opportunities in the next quarters to expand its US footprint and operational capabilities. But the success is not a sure thing and an acquisition could end up being a failure. For instance, HCCI may not be able to successfully integrate the acquired business without substantial expense and/or the acquired business could fail to generate anticipated revenue or earnings.
Takeaway
HCCI has been an outperformer since late 2020, when we advised subscribers to our research to buy it at $14 per share. This outperformance was largely the result of the company’s operational excellence over the last twelve months, rock-solid balance sheet, and low key metrics.
At the current price of $28 per share, we believe that the easy money has been made. However, the company has a growth strategy in place and its key metrics currently are not high. Therefore, barring unforeseen events, upside still exists based on a 2- to 5-year investment horizon.
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