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Morningstar | Pricing Reset Needling Stericycle's Growth, but Shares Undervalued

Narrow-moat medical waste industry leader Stericycle has grappled with negative investor sentiment, some of it warranted, for several years. This was driven in large part by the emergence of painful contract concessions in its premium-priced small-quantity, or SQ, waste-generating account base, coupled with guidance shortfalls and lackluster performance in the noncore industrial hazardous waste unit. Importantly, SQ pricing rollbacks are the fruit of a decade of consolidation of small physician practices into large hospital groups with stronger buying power as well as pushback from existing small independent healthcare customers looking to slash costs against an inflationary backdrop.

However, our analysis suggests Stericycle's market price is now baking in overly pessimistic midcycle revenue and profitability assumptions. Execution risk adds uncertainty to the equation, but pricing headwinds of the current magnitude are probably not permanent, and we expect the flagship regulated med-waste division to gradually rekindle low- to mid-single-digit organic revenue growth. The shares trade at a 29% discount to our $86 fair value estimate, offering a buying opportunity for patient, long-term-minded value investors capable of stomaching heightened volatility in the year ahead.

Stericycle's market price appears to be baking in the prospect of material long-term pricing concessions that would relegate the core med-waste division to flattish midcycle organic revenue growth. We disagree. Pricing pressure, which emerged in 2016, should abate in 2019 as the firm cycles through SQ contract renewals and as negative publicity from the recently settled SQ class-action lawsuit dissipates. According to our analysis, concessions thus far haven't deteriorated beyond management's original forecasts.

We don't expect the company to return to its glory days of high-single-digit organic top-line expansion with 30% EBITDA margins. That said, we think midcycle consolidated (and med-waste segment) organic revenue growth of 3.5%-4.0% and material margin improvement are achievable against a stable pricing backdrop, with incremental help from upselling ancillary services and efficiency optimization.

For a deeper dive, please refer to our September 2018 report, "Pricing Reset Needling Stericycle's Growth, but Shares Undervalued," Stericycle Management is participating at the Management Behind the Moat conference held at Morningstar’s Chicago office on November 7-8, 2018. If you are interested in attending, please reach out to your sales representative for registration information.