ClaudineVM
Elevator Pitch
I rate Stericycle, Inc.’s (NASDAQ:SRCL) stock as a Hold.
I evaluated SRCL’s pace of recovery from the pandemic and its capital allocation plans in an earlier October 22, 2021 article for the stock. I focus on the near-term expectations for Stericycle in this update. My analysis leads me to the conclusion that the consensus earnings forecasts implying a mid-single digit percentage decline for SRCL in FY 2022 are realistic, and Stericycle’s current valuations seem to be fair taking into account the full-year outlook. As such, I maintain a Hold rating for SRCL.
Revisions To Consensus Estimates
The recent changes to the sell-side’s consensus bottom line forecasts for Stericycle provide an indication of what the market expects of SRCL’s future performance.
The consensus Q3 2022 normalized earnings per share or EPS for SRCL has been revised upwards by a substantial +11% in the past one month. It is reasonable to assume that the Wall Street analysts had raised their third-quarter bottom line projections for the company in response to Stericycle’s +9% EPS beat for Q2 2022. It is worthy of note that SRCL has had earnings misses for the prior four quarters between Q2 2021 and Q1 2022.
But the full-year fiscal 2022 consensus numbers tell a different story. In the last one month, the market’s consensus FY 2022 normalized EPS estimate ($2.06) for Stericycle has in fact been reduced slightly by -0.5%, notwithstanding SRCL’s second-quarter earnings beat. Moreover, four of the eight analysts covering SRCL’s shares actually lowered their EPS estimates for the company in the past month.
The analysts’ less than favorable view of Stericycle’s full-year FY 2022 outlook might be linked to the company’s most recently updated management guidance. At its Q2 2022 earnings call in early-August 2022, SRCL increased the mid-point of its FY 2022 revenue growth guidance from +4% to +5%, but it lowered the mid-point of its full-year EPS guidance from $2.15 to $2.075 (implying a -5% decline as compared to 2021 EPS of $2.19).
In the rest of the article, I will assess the growth prospects of its two key business segment and the company’s overall profitability. This will help to explain why company management and analysts are of the opinion that Stericycle’s bottom line for FY 2022 will still contract despite above-expectations Q2 2022 earnings.
Secure Information Destruction Business Performed Well in Q2
Organic revenue for Stericycle’s secure information destruction business, adjusted to exclude inorganic transactions and foreign exchange effects, expanded by an impressive +12.2% YoY for the second quarter of 2022.
The expectations for SRCL’s secure information destruction segment weren’t high, as this business faces structural challenges relating to reduced paper usage in an increasingly digitalized world. However, the company’s business secure information destruction business has witnessed a meaningful recovery in Q2 2022, as pandemic restrictions are eased and an increasing number of workers return to offices.
More critically, the current recovery for the secure information destruction segment still has legs to run. Stericycle highlighted at its second-quarter results briefing that “I don’t think the industry has settled yet in terms of everybody being back to what is the new normal.” In other words, SRCL is implying that there could be a further acceleration in the pace of people going back to offices in time to come, and this will be positive for the secure information destruction business’ near-term outlook.
Disappointing Performance For Regulated Waste And Compliance Services Segment
In contrast with the double-digit top line growth for the secure information destruction segment in the recent quarter, Stericycle’s other segment, the regulated waste and compliance services business disappointed investors with its Q2 2022 results. Specifically, the regulated waste and compliance services segment saw a very modest +1.8% YoY increase in its second-quarter organic revenue.
Notably, SRCL mentioned at its Q2 2022 earnings briefing that “most of the growth” for the company’s regulated waste and compliance services segment for the most recent quarter “was due to pricing.” This suggests that volumes for this business was probably flattish on a YoY basis in the second quarter of this year.
There are two key factors that explain why the regulated waste and compliance services business’ volumes haven’t grown in a meaningful way in the recent quarter. Firstly, there was a decline in COVID-19 testing and vaccinations in Q2, as COVID-19 transitions gradually into an endemic state. Secondly, the labor crunch has also affected the healthcare industry, which means that it is tough for the number of elective surgeries to return to similar levels seen before the pandemic anytime soon.
Future Profitability Hurt By Operating Cost Pressures And Higher Interest Rates
As discussed in an earlier section of the article, Stericycle cut its full-year FY 2022 bottom line guidance after it reported its Q2 2022 earnings. SRCL attributed this change to “higher cash operating and interest expenses” at its most recent quarterly investor call.
With regards to the rise in operating expenses, SRCL’s non-GAAP adjusted EBITDA margin decreased by -3.4 percentage points YoY from 19.4% in Q2 2021 to 16.0% in Q2 2022 as a result of inflationary cost pressures. The company’s adjusted EBITDA margin did improve by +3.0 percentage points on a QoQ basis in the recent quarter due to price increases. But the fact that Stericycle’s management chose to provide lower EPS guidance implies that price hikes are insufficient to fully offset the spike in costs driven by inflation.
In terms of interest expenses, Stericycle noted in its Q2 2022 results presentation slides that the company’s updated management guidance incorporates expectations of “increased interest rates with an expected unfavorable impact of $0.04 to prior year, which is $0.02 higher than prior guidance.” The rising rate environment is negative for SRCL which has a fair amount of financial leverage. Stericycle disclosed in its second-quarter earnings presentation that its leverage ratio was 4.02 times as of end-June 2022, which is still higher than its targeted leverage ratio of under 3 times that it hopes to achieve by the early part of next year.
Closing Thoughts
The Hold rating for Stericycle’s shares stays unchanged. SRCL currently trades at a consensus forward next twelve months’ normalized P/E multiple of 20.4 times as per S&P Capital IQ, and this is roughly on par with the stock’s five-year average forward P/E ratio of 20.7 times. Taking into account the muted full-year FY 2022 outlook (slight bottom line contraction), SRCL appears to be fairly valued now justifying a Hold rating.
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