EUR 850.00 For Business Accounts Only

Morningstar | Plentiful Noise in Stericycle's 2Q, But Core Med Waste Trends Mostly in Line; Shares Attractive

Narrow-moat medical waste specialist Stericycle's second-quarter revenue declined 3.2% on an organic basis. Revenue trends came in shy of our expected run rate for the year mainly because of a weaker-than-expected showing in the communication services division, or C&RS, which saw less recall project work and a falloff in call volumes. Core regulated medical waste segment organic revenue fell roughly 4%, which didn't deviate drastically from our expected run rate (it came in ahead last quarter). This segment has been a key focal point for investors given ongoing small-quantity, or SQ, customer pricing concessions. Of note, management lowered its med waste division 2018 revenue guidance, which came in below our previous forecast, but at first glance, we think that's in large part because of the impact of recent divestitures and unfavorable foreign exchange. Our conversation with management following the call gave us confidence that SQ-account pricing headwinds have not accelerated beyond our previous expectations, which would be our key concern. Stericycle's consolidated adjusted profitability came in slightly short of our expectations, but we suspect that is because of lost leverage from lower revenue at C&RS. Realized annual EBITDA cost savings associated with "transformation" efforts are generally on track.

We tempered our revenue growth forecasts for 2018, and to a lesser degree 2019, to reflect divestiture activity in the med waste segment and M&I hazardous waste unit, foreign exchange headwinds, and the anemic C&RS performance. However, that impact was offset by the time value of money since our previous update. We are maintaining our longer-term midcycle model assumptions. As a result, we don't expect to materially alter our $86 fair value estimate. As of market close on Aug. 2, the shares were trading at a healthy 17% discount to our fair value estimate.

We think the stock may see near-term selling pressure, in part because management lowered its revenue and EPS guidance ranges for 2018. This comes amid the backdrop of numerous earnings misses over the past year-plus (save for first-quarter 2018 results)--the stock has in many ways become a "show me" story. However, our initial take is that management lowered guidance because of foreign exchange headwinds and the C&RS shortfall (C&RS project business is lumpy to begin with), not because of incremental deterioration in the core med waste businesses or faltering execution in terms of recently implemented turnaround efforts (including a large multiyear ERP rollout). Our thesis remains intact. Stericycle has seen several headwinds arise over the past year, but in our view, market sentiment is overly negative, and the current valuation offers an attractive entry point for patient value investors willing to stomach near-term volatility.