It is easy to be skeptical of companies who do a lot of M&A or are in boring businesses such as waste disposal. This company will prove you wrong. Stericycle Inc (NASDAQ:SRCL) is a medical waste disposal company providing its customers with regulated waste management and other related services such as regulated recall, returns management, and patient communication.
Stellar financial track record validates attractive business
Stericycle Inc (NASDAQ:SRCL)’s financial track record will put many companies to shame. It has been profitable and free cash flow positive in every single year in the past decade. It also grew its revenue and net income by a 10-year CAGR of 16.9% and 19.3%, respectively. In addition, Stericycle exhibits strong margin stability with gross profit and net profit margin staying within a reasonably consistent range of 43%-47% and 11%-15%, respectively. There are a few reasons for this, in my opinion.
Firstly, regulatory barriers and the high benefit-to-cost ratio of Stericycle Inc (NASDAQ:SRCL)’s services lend support to its recession resistant revenue. Regulated medical waste refers to any medical waste with the potential of spreading infections such as needles, syringes, gloves, and other blood products.
Stericycle holds various permits pertaining to environmental protection, employee health & welfare, and waste transportation, effectively creating barriers to entry for new entrants. Moreover, the cost of Stericycle Inc (NASDAQ:SRCL)’s services is relatively small compared with the potential legal liabilities associated with the improper disposal of medical waste.
Secondly, size and location matter in this industry. As the largest medical waste disposal company in the U.S. and an estimated 14% global market share, Stericycle boasted of a national network of 219 processing facilities and 141 transfer sites in the U.S. at the end of 2012. Given the localized nature of the waste collection and disposal business, Stericycle Inc (NASDAQ:SRCL)’s extensive distribution network gives it an edge over its competitors.
Last but not the least, Stericycle has high customer retention rates in excess of 95%, based on revenue. This is the result of customer diversification with its largest customer accounting for less than 2% of its revenue and a large proportion of multi-year long term contracts with built-in renewals.
Acquisition-driven growth is not that risky after all
I know of investors who are skeptical of serial acquirers and will not touch these stocks with a ten foot pole. I prefer to keep an open mind and view the company’s track record and acquisition capacity in perspective.
In Stericycle’s case, its track record speaks for itself, having completed more than 300 acquisitions in the U.S. and overseas since 1993. Management disclosed that acquisitions have contributed to $100 million of current revenue. Another thing to note is whether Stericycle is overstretching itself. Given that free cash flows have been consistently positive and gearing is manageable at below 100%, I do not think that this is an issue.
In the first quarter of fiscal 2013, Stericycle Inc (NASDAQ:SRCL) achieved a good set of results, growing its quarterly revenue and net income by 11.7% and 14.9% year-on-year, respectively.
Going forward, Stericycle’s key strategy is to grow its share of small account customers vis-à-vis large account customers. Small account customers deliver high margins for Stericycle, as they are more likely to take up complementary services such as patient communications, compared with their larger counterparts.
Patient communications services include automated appointment reminders, appointment scheduling, physician referrals, post discharge, and wellness calls. As a comparison, Stericycle’s gross margin more than doubled from 21% in the fourth quarter of 1996 to 45.2% in the most recent quarter, as a result of growing its small account customer share of domestic revenue from 33% to 63%. This is a clear illustration of Stericycle’s potential for margin expansion.