Clean Harbors, Inc. (NYSE:CLH) Q3 2023 Earnings Call Transcript

Clean Harbors, Inc. (NYSE:CLH) Q3 2023 Earnings Call Transcript November 1, 2023

Clean Harbors, Inc. misses on earnings expectations. Reported EPS is $1.68 EPS, expectations were $2.07.

Operator: Greetings, and welcome to Clean Harbors Third Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Michael McDonald, General Counsel. Thank you, sir. You may begin.

Michael McDonald: Thank you, Christy, and good morning, everyone. With me on today’s call are our Co-Chief Executive Officers, Eric Gerstenberg and Mike Battles; and our EVP and Chief Financial Officer, Eric Dugas; and SVP of Investor Relations, Jim Buckley. Slides for today’s call are posted on our Investor Relations website, and we invite you to follow along. Matters we are discussing today that are not historical facts are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Participants are cautioned not to place undue reliance on these statements, which reflect management’s opinions only as of today, November 1, 2023. Information on potential factors and risks that could affect our results is included in our SEC filings.

The company undertakes no obligation to revise or publicly release the results of any revision to the statements made today other than through filings made concerning this reporting period. Today’s discussion includes references to non-GAAP measures. Clean Harbors believes that such information provides an additional measurement consistent historical comparison of its performance. Reconciliations of these measures to the most directly comparable GAAP measures are available in today’s news release, on our website in the appendix of today’s presentation. Let me turn the call over to Eric Gerstenberg to start. Eric?

Eric Gerstenberg: Thanks, Michael. Good morning, everyone, and thank you for joining us. Turning to our Q3 financial performance on Slide 3. Our Environmental Services segment delivered its eighth consecutive quarter of profitable growth in Q3, and we expanded our margins by 120 basis points. While we experienced some planned challenges in the quarter, demand remains high for those scarce assets that support our disposal and recycling services. Within our services businesses, our trained and skilled workforce continues to be highly utilized and in demand from customers. Our SKSS segment faced some production challenges at our re-refineries in the back half of the quarter that led to lower-than-expected sales volumes and profitability.

While volumes were off, pricing significantly improved in late Q3, with our aggressive shift to a higher charge for oil throughout Q3, we cycled through our higher-priced inventory, and we have returned to full production in our plans to start Q4. All of this will enable us to end the year strong in SKSS. Mike will discuss more of this in his prepared remarks. Given some of the challenges arising in both operating segments, we fell short of our financial expectations in Q3. About half of the Q3 miss was related to Environmental Services segment and the other half was related to SKSS. We will get more into the details in each in a moment, but we believe our Q3 shortfall is unrelated to demand or market conditions. We believe the outlook for both segments continues to be strong.

Before turning to the segment detail, I want to highlight our outstanding safety results. Safety forms the backbone of our reputation and our relationship with our customers. In Q3, the team battled through record-breaking summer heat and other adverse weather conditions to deliver a quarterly TRIR of 0.62, the best Q3 in our history, which keeps us on track to achieve our ambitious annual TRIR goal of 0.70. To everyone on our team listening today, thanks for all you do and keep everyone safe and allow our colleagues to go home uninjured every day. Turning to Environmental Services on Slide 4. Segment revenue increased 6% due to growth of our services businesses, higher disposal revenue and the addition of Thompson Industrial. Overall, growth was underpinned by a mix of pricing and volume initiatives in the various business units.

In Q3, our Safety-Kleen Environmental Services business led the way with 14% top line growth, extending its already outstanding 2023. Parts washer services were up from prior year, reflecting the expansion of Everyday’s customer base for its core offerings. Field Service revenue was up 3% in the quarter, despite no large-scale emergency response events and a limited number of medium-sized projects. Technical Services rose slightly year-over-year, less than we expected, largely resulting from the backup of the incineration network and lower fuel recovery revenue this year versus last, when diesel prices hit $7 a gallon. While our facilities revenue grew in Q3, we expected a stronger performance, but we were impacted by the additional maintenance days, particularly in late September.

Overall, our plants have been running extremely hard since the pandemic with a highly complex waste streams and significant volumes of containerized waste. During the quarter, we had a pull forward of planned Q4 turnaround at our El Dorado facility to September to improve performance, which cost us approximately $8 million to $9 million of aggregate EBITDA between repairs and lost revenue. We also made some needed preemptive repairs and other critical investments at other locations that yielded about $3 million in additional costs than originally expected. We have been doing considerable repair work this year at our Southern plants due to the after effects of the deep freeze in the winter of 2021 and other small freeze earlier this year. Given these events, incinerator utilization came in below our Q3 expectations at 86%, flat with the prior year.

Average incineration pricing was up 3% in the quarter due to continued pricing initiatives offset by limitations on processing our backlog of containerized incineration waste in the quarter, mainly related to our plant turnarounds. We view this mix shift as temporary as the plants are running well today. The backlog in drum count, both at our site and within the marketplace remains at extremely high levels, which will drive more favorable mix in the coming quarters. Landfill volume in the quarter was up 19% as we won several large projects, including one in Western Canada. Base business and landfills also remains healthy. Industrial Services grew 5% in the quarter as we expanded our presence in the Southeast and into some select verticals such as the steel industry through the Thompson acquisition.

The team is focused on capturing significant cost synergies through Thompson and our second full year of owning HPC to improve margins in this business. Our results throughout 2023 reflect our success in those efforts. Turning to overall segment profitability. Adjusted EBITDA growth was 11%, far outpacing revenue as we leverage our network and vital fixed assets. The productivity and efficiency initiatives we have — that we have ongoing in both our plants and our service branches are having a positive impact on margins. We are taking out costs to counter inflation, but we are also exploring ways to apply data analytics, AI and robotic process automation to make profitability gains as we grow the business in the coming years. In Q3, we saw our ES margins top 25% with solid growth, and we see the opportunity to increase our longer-term ES margins to 30% or higher.

Before handing it off to Mike, let me provide an update on the construction of our Kimball incinerator on Slide 5. The $180 million project is proceeding extremely well. I recently traveled out to the facility and met with Nebraska Governor, Jim Pillen, whose administration has been very supportive of this project and the jobs it will bring to the western part of his state. Governor Pillen and the other elected officials signed the final steel beam that was put in place as part of the topping off ceremony in early October. When I visited the site, I was impressed by how well all the key components of the plan are coming together. Our team is doing a terrific job keeping us on track and on budget. As you can see on the slide, the rotary kiln is now in place as is the central steel structure of the plant itself.

In the coming months, we will be moving forward rapidly with construction. Our initial goal when we launched this project was to have the facility operational in the first half of 2025. Given that we are slightly ahead of schedule today, we are now targeting the new Klin start date to be prior to the year-end 2024. We are all excited to ship this incinerator into operation. Given the demand we continue to see in the marketplace along with what we expect to see in the years ahead from reshoring, national infrastructure investments and other trends. We are having good discussions with customers about their future needs as well as ongoing conversations with owners of captive incinerators. We expect 70,000 tons of capacity in Kimball to be readily absorbed by the marketplace.

With that, let me turn things over to Mike to discuss SKSS and the capital allocation. Mike?

Mike Battles: Thanks, Eric, and good morning. We’re all excited to see Kimball come online as rapidly as possible. It will be a big win for the company and our stakeholders. Moving to SKSS on Slide 6. This segment underperformed this quarter, but we’re seeing much better days here in Q4. On the top line, Q3 SKSS revenue declined 21%, primarily due to lower base oil pricing versus a year ago when supply and scarcity drove pricing to record levels. We entered Q3 in a downward trend in pricing with posted pricing dropping $0.60 in Q2, including a June reduction that impacted us in the first part of Q3. Subsequently, prices stabilized in mid-August, followed by a second price increase in September. Given the rising pricing environment, some of which did not take effect until October, we’re off to a good start in Q4 selling base oil in October at favorable pricing.

Looking at year-over-year profitability, after our record Q3 adjusted EBITDA a year ago, lower pricing in this year’s third quarter put pressure on our adjusted EBITDA and margins. In terms of expectations, the biggest factor to our miss in this segment was interruptions to expected production at several of our 8 re-refineries, including a delayed restart of our California facility. These reductions had the dual impact of higher-than-expected plant costs as well as lower volume of base oil and other products for us to sell. In fact, in September, we sold more than 4 million gallons less of base oil than we had forecasted when we spoke to you in early August. These repairs and costs were all completed in Q3 and said that our plants have run extremely well, including our California facility.

As most of you know, we actively manage the re-refining spread in this business. As we’ve outlined on previous calls, base oil pricing was on a downward trajectory for much of the year until recently. In response to market conditions, the SKSS team has been hypervigilant in addressing the spread compression we saw in the first 3 quarters. We have continued to collect the volumes we need for our plants at the best pricing possible to stabilize that spread. In Q2, we shifted from a pay-for-oil or PFO approach to a charge-for-oil model. In Q3, we raised that average CFO even further, while collecting 59 million gallons. As we look ahead to the fourth quarter, we see both ends of our re-refining spread improvement. We consumed our higher-priced inventory in Q3 and will benefit from lower-cost inventory being sold in Q4.

In addition, the 2 price increases we saw in the back half of Q3 were also benefit us in Q4 as we tend to sell greater volumes in the quarter. Blended product is another area where we see incremental sales momentum. This value-added set of products is derived from processing our base oil into finished lubricants such as such as hydraulic motor — motor oil or hydraulic fluid. Blended product sales accounted for 21% of the total output of our plants in Q3. That’s up from 17% a year ago and 19% in Q2 as we continue to win customers in this area. Our direct volumes, which represent our closed loop approach, were at 8% in Q3, up from 7% in Q2. Our goal remains to increase our blended volumes not only this year, but on a go-forward basis with both direct and wholesale channels.

Overall, it’s been a challenging year for SKSS, but the team has managed well through the pricing terminals. We are on track for record collections at favorable CFO levels and will deliver annual volume produced in our plants will produce — will deliver record annual volume produced in our plants despite the Q3 upsets. Strong Q4 will enable us to conclude Q3 and enter Q4 on a positive note in this segment. Even within a weak Q3, we expect this segment to still deliver on adjusted EBITDA margin north of 20% this year. It remains a strong cash flow generator and a high ROIC business for us. One of the ways we intend to profitably grow SKSS in the coming years is to upgrade some of our Group II output into Group III products. We’re excited to share today that we recently concluded a successful scale pilot project to make Group III oil at one of our plants.

We are confident that we’ll meet the required industry specifications to sell it into the marketplace. The value of qualified Group III base oil versus Group II varies over time, but more recently, it typically carries a premium of $1 to $2 per gallon. Throughout 2024, we intend to scale up the project and initially produced a few gallons — a few million gallons of Group III oil at one of our locations. We will then — we will then bring that successful program to some other facilities in the coming years to extract even more value from existing assets. Turning to Slide 7 and our capital allocation strategy. Nothing that happened in Q3 changes our perspective on the Vision 2027 strategy that we laid out at our Investor Day in March. We expect to grow both organically and through acquisition.

Given the highly leverageable network of assets and people, we have seen the positive margin improvement that economies of scale provide for both cost synergies and cross-selling. So whether it’s pursuing the next Kimball lite internal project for accretive acquisitions, we have multiple avenues for growth. We continue to assess opportunities to invest in CapEx to drive organic growth. On the M&A front, we evaluated a number of candidates in Q3 and, as always, remain highly selective. We continue to see a healthy flow of potential transactions for both operating segments. Eric Dugas will cover our balance sheet in more detail, but I wanted to highlight that we are very well positioned to be opportunistic with respect to potential M&A. At year-end, we expect to be at our lowest leverage point in more than a decade.

To summarize, while our Q3 results did not meet our expectations, we view the factors behind our performance and short term in nature. We expect our ES segment to deliver — to continue to deliver profitable growth and margin improvement in the coming quarters. We see high demand for our services nearly across the board with customers valuing our breadth of offerings and strong service and safety record. We expect each of our 4 businesses within the ES segment to achieve profitable growth in 2023. Our backlog of ways positions us to close out the year on an upward trajectory. The plans are running great and the project pipeline within the ES segment also remains healthy as spending on reshoring, government infrastructure and regulatory-driven cleanups continue.

Within SKSS, we remain focused on controlling costs across the business, particularly on the collection side, while still ensuring expense supply to maximize output at our re-refineries. Given where base oil and lubricant markets are today, we expect to post a large sequential increase in profitability in Q4 and enter 2024 with positive momentum in this business. With that, let me turn it over to our CFO, Eric Dugas.

Eric Dugas: Thank you, Mike, and good morning, everyone. Turning to the income statement on Slide 9. As Eric and Mike outlined, Q3 was a challenging quarter for us compared to expectations, particularly on the plant side, but the overall demand picture remains strong. Our ES segment continued to achieve profitable revenue growth, which essentially offset the year-over-year top line decline in SKSS that was driven by lower base oil pricing and resulted in Q3 revenues that were essentially flat with a year ago. As Eric Gerstenberg outlined at the start of the call, adjusted EBITDA came in below our expectations at $255 million, compared with the $308.6 million in Q3 last year. Our adjusted EBITDA margin in the quarter was 18.7%.

Gross margin in the quarter was 30.9%, lower than Q3 of last year, due to large year-over-year decline in SKSS. While ES gross margin was up 190 basis points to 33.2% as we offset inflation and wage pressures with appropriate pricing increases and realized cost savings. We remain focused on increasing productivity and operational efficiencies, along with pricing initiatives within ES, to continue to drive margin expansion. SG&A expense as a percentage of revenue was 12.5% in Q3 due to higher IT investments and related professional fees. For the full year, we now anticipate being in the mid-12% range. Overall, the team has done a good job managing SG&A headcount while battling inflation and wage pressures. Depreciation and amortization in Q3 increased to $93 million, consistent with our expectations and reflecting the Thompson acquisition completed earlier this year.

For 2023, we continue to anticipate depreciation and amortization in the range of $350 million to $360 million. Income from operations in Q3 was $154.4 million, down from prior year as expected, given lower overall profitability. Net income for the quarter was $91.3 million, resulting in earnings per share of $1.68. Turning to the balance sheet highlights on Slide 10. Cash and short-term marketable securities at quarter end were $420 million, up approximately $94 million from June. In looking at our debt portfolio, we remain very comfortable with where we sit today. We ended this past quarter with debt of $2.3 billion and with no currently outstanding amounts coming due until 2027. Leverage on a net debt-to-EBITDA basis as of September 30 remained at approximately 2x, and our weighted average pretax cost of debt at the end of Q3 was 5.4% with approximately 85% of our portfolio being at fixed rates.

Starting to cash flows on Slide 11. Cash provided from operations in Q3 was $220.1 million. CapEx net of disposals was $105.4 million in the quarter, up from prior year due to the Kimball project, which accounted for $22 million of our Q3 CapEx. In the quarter, adjusted free cash flow was $114.7 million. For 2023, we continue to expect our net CapEx to be in the range of $400 million to $420 million. Full year spend on the Kimball incinerator is now expected to be approximately $85 million. In addition to that project, we continue to see synergies to invest in other areas of the business, including equipment and our transportation fleet. These investments will minimize third-party rental spending as well as maintenance costs by replacing older equipment and foster growth through those added resources.

We also are continuing to invest in our plants, including winterization projects and our incinerators down south. During Q3, we bought back more than 58,000 shares of stock at a total cost of $10 million. Approximately $85 million remains on our existing buyback program. Moving to Slide 12. Based on our Q3 results, and current market conditions for both our operating segments, we are revising our 2023 adjusted EBITDA guidance to a range of $1.005 billion to $1.025 billion, with a midpoint of $1.015 billion. Looking at our annual guidance from a quarterly perspective, we expect Q4 adjusted EBITDA to be approximately 15% above Q4 of 2022 as we expect growth in both of our operating segments. For full year 2023, adjusted EBITDA guidance will translate to our operating segments as follows: in Environmental Services, we now expect adjusted EBITDA at the midpoint of our guidance increase nearly 15% in the full year of 2022.

With the Q3 plant challenges behind us, we expect higher production levels in Q4 as demand for our services continues to be robust. For SKSS, we now expect full year 2023 adjusted EBITDA at the midpoint of our guidance to decrease in the 40% range due to lower base oil pricing this year versus last. With the recent uplift in base oil pricing that Mike referenced, we expect to see a sequential increase in Q4 from Q3 that should allow us to close out the year strong. Our corporate segment, at the midpoint of our guide, we now expect negative adjusted EBITDA to be up approximately 9% this year from 2022. This reflects areas such as increasing insurance costs and salaries and benefits as well as the impacts of the Thompson acquisition. In light of the reduction in adjusted EBITDA, we are also revising adjusted free cash flow expectation for 2023.

We now expect free cash flow to be within the range of $300 million to $330 million for a midpoint of $315 million. Let me remind everyone that this year’s free cash flow guidance includes approximately $85 million for the Kimball incinerator project. If you add that spend back, the midpoint of our adjusted free cash flow guidance would be about $400 million or approximately 40% of our current adjusted EBITDA midpoint expectation. In conclusion, I want to echo some of the thoughts that both Mike and Eric shared. While we reported results below our expectations, nothing that has occurred in the quarter has changed our view of Clean Harbors’ multiyear growth prospects. Despite the planned challenges in the quarter, our ES segment delivered top line growth and leverage that to achieve meaningful margin expansion and increased EBITDA.

In our SKSS segment, our re-refineries are all back running well again, and our California re-refinery is back online. We expect a good Q4, enabling us to exit ’23 with positive momentum. Looking ahead, we remain enthusiastic about our growth prospects in both segments. Our sales and project pipelines remain healthy. And finally, while I appreciate the fact that analysts and investors want to ask about our expectations for 2024, consistent with our historical practices, we are not providing guidance at this time as we have a budgeting process that we need to complete first. I will say that there is nothing in our 2023 performance or in the market today, that leads us to meaningfully deviate from the 2024 expectations that we assumed in our Vision 2027 organic growth model that we introduced back in March.

And as Mike mentioned, we also intend to remain opportunistic on the acquisition front to complement our organic growth. With that, Christine, please open up the call for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Tyler Brown with Raymond James.

Tyler Brown: So I want to kind of make sure I have it. So I know that you didn’t give specific Q3 guidance, but you obviously had a number implied in your prior midpoint. So can you guys kind of walk us through the delta of, call it, this $255 million versus maybe the 2 — I’m going to say, $285-ish million, it was likely in that prior guidance. So basically, how does that $30 million breakdown? Was it $8 million to $9 million from Arkansas, $3 million from some other incinerators and then the rest was SKSS, is that a good way to break it down? Or just any help there would be helpful.

Mike Battles: Yes. Sure, Tyler. This is Mike, and I’ll answer the question. So the way it broke down from what we said 90 days ago was about $12 million of the miss was in the Environmental Services segment. As Eric mentioned in his prepared remarks, is centered around pulling the turnaround forward around — along with some other challenges, some preemptive things we did at the other plants. About $13 million of the miss is in the SKSS segment, and that has a double impact of a plant going down late in the quarter as well as — so that’s additional cost to get it back online as well as a lost revenue from not being able to sell that much oil in Q4. And as I said in my remarks, we were down 4 million gallons in the month of September, which was a surprise to us.

The last piece was corporate costs — last piece, Tyler, was corporate costs of about $5 million. There was some one-off projects we did that cost us more than we expected in the quarter as well as insurance costs.

Tyler Brown: And then on SKSS, what exactly happened? Was it a mechanical issue? Was it a chemistry problem? I’m just curious.

Eric Gerstenberg: Yes, Tyler, this is Eric. Just to clarify that within SKSS, we were starting up. We didn’t have an accelerated turnaround come forward from Q4 into Q3. And SKSS, what we were doing is we were restarting our California-based plant coming online for base oil. We started that plant up earlier in the year. We were making VGO. And as we progress through Q3 — as we progressed into Q3, we anticipate being online for base oil and generating base oil and selling that volume. Actually, we brought it online delayed in the quarter at the tail end of Q3, which was the effect there. Along with some other minor production issues at some of the other plants. But the core issue in our SKSS segment was bringing on the California refinery later than we expected generating base oil.

Tyler Brown: Okay. Okay. That’s very helpful. On the Group III pilot program, I think, Mike, you said it would be a few million gallons in ’24, but how big do you think that could be over the next few years? Seems like $1 or $2 uplift is a pretty big deal. And was that contemplated in that Vision 2027?

Mike Battles: Tyler, so yes, we did envision having some Group III base oil in the Vision 2027 is kind of how we get back to 2022 levels, how we get back to $300 million plus. Group III base oil was certainly part of that. We think that gets up to — depending on how we do it and how many plants we can roll it out to. It was a very successful pilot. It could be 25 million gallons or greater. And so I’m of the view over the next couple of 3 years, that becomes part of our process, and we are really excited about that pilot, and we’re going to make a lot of that base oil in 2024. We’re going probably use it more internally to make blended oil ourselves, but there will be something to sell in the marketplace, and we’re excited about that.

Tyler Brown : Okay. Good. And my last one here. I know there’ll probably be some talk about demand. It sounds like demand is pretty good. But did the auto industry disruptions impact you at all noticeably in Q3?

Eric Gerstenberg: Yes, Tyler. Eric answering here. We did have some effect of the auto strikes, both in our industrial services business and some of the waste streams that some of the supporters, suppliers to the auto industry have. They were off in Q3. But we see that coming back as we get into Q4 here.

Operator: Our next question comes from the line of Michael Hoffman with Stifel.

Michael Hoffman: Your day reminds me of an old John Wayne movie, when we got asked off day or day off. So when I look at — just to get the numbers right, I mean, the simple math is you land on ES at around $1.89 billion, $1.90 billion, SKSS set $185 million. You got $259 million of corporate overhead. There’s your midpoint of your guidance. Is that — to Mike, that’s the neighborhood we should be in, right? I mean that’s this…

Mike Battles: Yes. Yes, maybe a little lighter in SKSS and maybe a little higher in ES, but I think directionally, you’re right.

Michael Hoffman: Okay. So that puts us — if I’m a little lighter, I’m in a $56 million, $57 million kind of quarter pace. You can’t annualize it because 1Q is a little weaker. But if I did a sort of 3x that plus the 1Q, that puts us in the low $200s million for next year. I know you’re not doing guidance, but we all have the model, and it would be silly for us to be sent out there with something stupid.

Eric Dugas: Yes. Mike, I think as I said in my remarks, we can’t give kind of full year guidance, but I think you’re kind of within the area code of what we’re thinking there.

Michael Hoffman: And then back to, if you have just normal plant activity, utilization rates, normal maintenance cycles, again, we’re sitting here looking at something that’s like 7%, 8% segment EBITDA growth in the ES business, that’s not an unrealistic way to think about it as well.

Mike Battles: Yes. No, that makes sense to us. And just to ground people in the — for the year, if we hit the midpoint for Environmental Services, if we hit the midpoint of our guide we gave this morning for the year, for 2023, it will be 9% revenue growth, 15% EBITDA growth and 150 basis points of margin expansion in 2022. So to think for a moment that 6%, 7% or whatever number you were talking about, Michael, about EBITDA growth into 2023 — 2024, excuse me, that doesn’t seem crazy for me.