Heritage-Crystal Clean, Inc. (HCCI): This Stock Is Not Justified Trading At A Premium To Its Peer

Heritage-Crystal Clean, Inc. (NASDAQ:HCCI) may have a strong balance sheet with little debt, but its smaller size and razor thin margins do not justify a premium valuation over its peer Clean Harbors Inc (NYSE:CLH). Clean Harbors owns Safety-Kleen, a clear market leader in parts cleaning and used oil re-refining – two of the key segments in which Heritage-Crystal Clean, Inc. (NASDAQ:HCCI) competes in.

Moats that matter

Heritage-Crystal Clean, Inc. (NASDAQ:HCCI) is the second largest provider of parts cleaning services in North America, and also the second largest re-refiner in the U.S, behind Safety-Kleen. But market share may not count for much, when new entrants can gain a foothold in the industry easily. That is where barriers to entry are important. Route density is an important profit driver for companies in the industry, and it will require significant effort and time for competitors to build a branch service and transportation network of the same scale as Heritage-Crystal Clean, Inc. (NASDAQ:HCCI). Heritage-Crystal Clean currently operates from more than 70 branches servicing 42 states, and opened three new branches in the beginning of 2013.

In addition to the huge capital outlay involved in building used oil re-refining plants and supplying parts cleaning equipment, environmental permits or approvals are also required for some of Heritage-Crystal Clean, Inc. (NASDAQ:HCCI)’s operations, such as those regulating the level of emissions. This is also precisely why companies have to outsource waste treatment and disposal services to service providers such as Heritage-Crystal Clean, since it is for difficult for them to meet such stringent requirements demanded by regulators.

Growth drivers

Heritage-Crystal Clean, Inc. (NASDAQ:HCCI) has different strategies in place to grow its used oil re-refining and environmental services businesses respectively.

It plans to increase its oil re-refining capacity to capitalize on the huge used oil industry re-refining opportunity. According to an article which referenced a Used Oils and Re-refined Lubricants report published by Kline, increased collection volumes and improvements in re-refining technology are expected to drive an increase in re-refining capacity in the United States from less than 0.8 million metric tons per year in 2012 to more than 1.2 million metric tons by 2017.

For its environmental services business, Heritage-Crystal Clean, Inc. (NASDAQ:HCCI) plans to grow by widening its service offerings, as it is usually much easier to sell new products to old customers, than to win new customers. According to its 2012 Fourth Quarter Conference Call, only slight more than half of Heritage-Crystal Clean’s branches offer vacuum truck services, offering the opportunity for it to cross-sell these services to its existing customers.