Clean Harbors, Inc. (CLH) Earnings Call Transcript & Summary

Everyone, this is Matt Fields. I cover high-yields, industrials for Bank of America. Welcome to day 2 of our 2020 Virtual Leveraged Finance Conference. We're pleased to have you participating with us. With me is Mike Battles, Chief Financial Officer of Clean Harbors; as well as Eric Dugas, Chief Accounting Officer of Clean Harbors. It's my pleasure to welcome them and thank them for their continuing support of our conference. We have a fireside chat format for everyone today. So I think we're just going to jump into some questions.

We're going to talk about the business and the sort of overall business environments, and then we'll go over some more financially specific question. So if it's okay, I think I'm going to start with a little bit of sort of impact to the business from the pandemic and some of the different -- and to other segments of the business. So first, starting in Safety-Kleen, just like to think about what the exposure in auto sales and sort of automotive end markets with dealers, with body shops, et cetera, you saw this year? How the pandemic has affected it? And kind of what's the outlook as we start to see some sort of additional shutdown orders heading into the winter?

Great. Good morning, everyone, and thanks, Matt, and Bank of America for having us at your conference. I'm sitting in my office here in Norwell, Massachusetts on a rainy Tuesday versus in Sunny Florida. But anyways, we will do our best in the COVID world that we live in. To answer your question on Safety-Kleen. So obviously, with the shutdown, it acutely affected our business in SK, both on the SK branch business and on the SK oil business. And in Q2, a very drastic shutdown and rollback. Q3 was better than Q2 and closer to 90% of where we were in 2019. We had talked about being closer to 100% by the end of the year. Maybe that takes longer. Tough to tell today. We haven't really seen a lot of shutdowns affecting the business directly yet, but to be fair, we read the same paper as everybody else reads. And we are certainly concerned about the spike in cases, the spike in hospitalizations and how that affects different states and their views on stay-at-home orders. And if that were to happen, and that would certainly have a material impact on the SK business. But as I sit here today talking to the team, I haven't seen it yet, but certainly, that's a concern. On the offset to that, of course, Matt, is the decontamination work that probably continues a little at a higher level than what we had expected. We expected as we gave out kind of Q3 -- Q4 guidance for the year, we thought that was going to slow down and perhaps that's not still kind of -- fortunately -- and unfortunately, not slowing down. And so that's been, what I would say, kind of a natural hedge within the part of the business that has been kind of a pleasant surprise here in 2020.

Okay. Good. Can you just give us a little color behind that, what kind of decontamination work are you doing? How do you see this going in the fourth quarter and perhaps into '21? And then, rolling into next year when we have this kind of unprecedented vaccine rollout, potentially 500 million doses in the U.S. What -- does Clean Harbors have any kind of role in disposal, decontamination, any kind of work in that rollout?

Yes. Matt, this is Eric Dugas. Maybe I'll attack this one, and then Mike can add color at the end. Specific to the type of work that we're doing, our guys are going out on an emergency response basis or a scheduled basis in certain situations. We may go out to -- let's use a supermarket chain as an example. We may go out on a routine basis or somebody at the supermarket may have contracted the virus. We'll go out. We'll do a strong wipe down with strong disinfectants. We may even do some defogging of the location. So it might be a retail spot, like I just described. We'll also do this similar type of services out at warehouses or anything like that. There's probably 1,000 different examples of the type of buildings, certainly schools, other public places. I think we even contracted some work with some public transportation type customers, so a lot of that type of work. We're using, for the most part, our internal resources. So not having to kind of subcontract work out like we have on other large emergency response jobs in the past. So that really helps the bottom line. As we move into Q4 and then maybe as the calendar turns, similar to what you see in the news, the virus unfortunately is not going away, and our work relative to this type of decontamination response continues. Certainly, I think in November and on into December here, we've seen a little spike in the work. I'm not sure we'll hit kind of Q3 levels. But as Mike said, I think over 100 million for the full year. As we turn the page into 2021, again, I think in the first quarter, before there's a mass vaccine, we'll continue to see high level response rate here. Hopefully, it's not a repeat of 2020, but we do think we'll see some significant volumes kind of in Q1. Relative to your comment on kind of what our role might be in terms of rolling out a vaccine, time will tell on that. I will say that we did see some work relative to some pop-up hospitals. And I even think some of the testing stations that were created, we did some kind of medical waste disposal related items there and maybe that provides a nice linkage to some sort of rollout plan of the vaccine in 2021, but time will tell.

Okay. Maybe you can remind investors about kind of the stickiness of some of your business and go over some of the contract structure on the services side of your business, especially.

Yes. So -- this is Mike, Matt. I'll jump on this one. So the contracts are annual contracts, but it's not as -- it's a lot more stickier than you would think. Because for a large chemical company to qualify, a company like Clean Harbors to kind of go on to their site, pick up waste and remove it from their site and dispose it in accordance with and give them the comfort that it has been disposed and incinerated or put into a hazardous landfill properly, that requires regular auditing, regular inspections, a real relationship. So I would say that although our contracts are annual contracts and that they can certainly -- every year they get renegotiated, if you will. It really is very hard to switch. There is a very high switching costs associated with certainly on our environmental services business, on our technical services business, on the main parts of our business. When you think about Safety-Kleen, we do have some churn in that business. There are other competitors out there, but we are, by far, the largest in the space as far as from parts washer services and collecting of used motor oil and kind of 2 or 3x the size, our next largest competitor. And so it does preclude some customers from making changes if they don't have another company in the area that can do that type of work. So I'd say that although our contracts are not structured multiyear contracts, they certainly are very sticky. And we don't have a ton of churn in our customer base.

Okay. That's helpful. Speaking of kind of switching costs and difficulty in getting qualified, I think you guys have said in the past that sort of regulatory -- strict regulations kind of help Clean Harbors in that the stricter the regulation is the fewer people can do it, and that kind of helps you out. Can you give us a kind of update on the regulatory environment that we're seeing and maybe kind of that you're anticipating heading into a Biden administration? And how kind of you are positioned to either potentially suffer or benefit from that?

Yes, Matt. So it really is something we need -- we try to clarify with investors all the time, both debt and equity investors, is that kind of when you think about a Presidency, whether it be Trump, Biden, Obama, whomever, it doesn't -- what we're talking about is kind of some of the most dangerous chemicals known to man. And whether they're going to make certain parts of the environmental protection agencies more stricter or less strict -- what we're talking about are more kind of air quality, fuel efficiency type of rules because you wouldn't want to roll back what we're talking about here. The stuff that is -- gets on these hazardous rules have never get removed because they're very, very dangerous. And so as such, it really is hard to kind of say what a Biden presidency may do for us or against us. I think, directionally, I think that's been helpful. But the different types of business regulation that span the whole industry came from Republican presidencies. So I wouldn't read into a Biden presidency versus a Trump presidency and what that means for us. I would say, though, that areas like PFAS and PFOA, which has been in the news quite a bit and how dangerous those chemicals are and how they need to be kind of addressed both in water and in soil. I mean obviously, we think a more active regulatory environment would help us. We think, in my mind, that may -- may go a little faster than under a different presidency. But that's really more on the rounds, I would say. I think that PFAS regulation is coming, it's just a matter of how fast.

That's interesting. And there hasn't been a whole lot of regulatory updates in your space since the IMO sulfur rules change, right, this year. Can you give us just a reminder of kind of what that was and how that affected your -- I think, specifically your maritime business this year and maybe into the future?

Yes. So just for people who don't know, the IMO regulations came out in early 2020, it's called IMO 2020, which really lowered the amount of sulfur that can be used in fuels for ships. And from like 5% to 0.5% or some small -- some very small percentage. And as such, the use -- so part of -- when you pick up, collect used motor oil from a dealership or from an auto repair shop, and that fuel can be used in those ships to burn to fuel the ship. But with those new more stringent regulations, because those things have solvent -- have metals and solvents in the actual oil that actually create this type of high sulfur type of fuel, you can't use that type of fuel in those ships anymore. And so as such, there's less outlets for that waste oil. And as such, there's an opportunity for Clean Harbors to charge more to pick up that used motor oil and feed our re-refineries. So simply stated, that's how it's supposed to -- that's how the new rules came into effect, and that has gone into effect, and it has been helpful. It's just given the lack of demand, given the pandemic, that's really slowed us down. And really, that's what's driving it. So to answer your question, Matt, the new regulations on IMO was very helpful for a company like Clean Harbors and will be helpful for a company like Clean Harbors. It's just -- in 2020, with the pandemic and the complete drop in shipping that really -- the demand for oil and demand -- has really hurt our business. And as such, there wasn't as much used motor oil to collect and as such, it could be -- it wasn't much of a lift in 2020.

Can you give us a sense of how much -- maybe not direct sales to the shipping industry, but how much of a sort of pre-pandemic level that kind of side of your business was versus during the pandemic, so we can sort of have a maybe some kind of estimate for what pickup could be kind of as we emerge from COVID and its effects?

Sure. So let me just clarify one thing, though. We don't really deal with the shipping industry, though. We don't really sell a lot of clean motor oil to ocean bearing vessels. It really is more of the fact that an outlet for our -- for that waste oil has been eliminated or has been severely constrained. And so that's how it's affected us. And so our ability to charge more for that oil just -- we collect 240 million, 250 million gallons of oil every year. So if that goes up by $0.01, that's $2.5 million of incremental profit to our business. And so if there's less outlets for this oil and we can charge another $0.01 or even another $0.10 for that waste oil, that turns out to be hugely profitable for Clean Harbors. And that's why people are excited about the possibility of IMO 2020 and the lack of available outlets for that used motor oil and our ability and our competitors' ability to charge more for that used motor oil. It's a huge profit differentiator.

Right. Right. Okay. One of the initiatives you've sort of been talking about for a while now has been increasing cross-selling opportunities between Safety-Kleen and Environmental Services. What's the opportunity you see there? And can you kind of give us an update on the progress you've made?

Yes. So we have done a really good job of co-locating assets to moving in, whether it be SK into Environmental Services type of branches or vice versa. Here in 2020, we finally merged the SK branch business leadership into the Environmental Services leadership team and that's really helped jump-start the cross-selling and the sharing of costs and resources in that business. At the end of the day, one is providing environmental services like picking up dangerous chemicals, and the other is doing a parts washer cleanout and picking up small quantity generations of waste in 55-gallon drums. So it is a little different. But there have been good cross-selling opportunities. Certainly, Matt, with the pandemic and our ability to sell decontamination services to our Safety-Kleen customers has been a huge win for us because they have the same types of problems as our Environmental Services customers.

No, that's a good point. And I think, from my point of view, an interesting kind of metric to gauge is how kind of difficult or easy it is to kind of increase your route density by sending essentially the same truck to perform multiple tasks. How kind of easy has that or difficult has that been for you? Is there certain things that a Safety-Kleen truck can do services, but a services truck can't do Safety-Kleen jobs, have you found any sort of unique challenges that way?

Yes. Certainly, when you're thinking about picking up hazardous waste in a tanker car, it's a different type of truck than a box truck going to do a kind of picking up some small quantity, 55-gallon drums. That being said, we do have a retail business that has been growing very well. Still pretty small, under $100 million business, but that retail business is perfectly aligned to -- based on route density and leveraging the Safety-Kleen trucks to go pick up small quantity waste at our retail location. So going to a Walmart and going picking up fertilizer, which you can't put into a dumpster or things like that, that's split or broke open or expired. Those types of things are -- will be -- ultimately be a great leverage of our Safety-Kleen box trucks and leverage that business together. But right now, it's still a little separate. But it can be done and that's the goal when we get to 2021 is leveraging our retail business with our Safety-Kleen branch business.

So you guys -- the business looks pretty different than it was 4, 5 years ago, you've rationalized your portfolio a little bit. You sort of conglomerated segments a little bit. Any portions of your business at this point that you consider noncore? Any desire to sort of further pare down your portfolio?

Yes, we're constantly thinking of kind of good companies, add well and divest well. And that's something we hadn't done -- going back 4, 5 years, we hadn't done a lot of. We have sold $120 million worth of revenue. We have done 6 or 7 different transactions. We'll continue that in 2021, probably in the smaller area, probably more in Western Canada. But certainly, that's on the docket to continue down that path.

Okay. Great. And then I think on the other side of that coin, how does Clean Harbors fit into any kind of industry consolidation? Are there -- what kind of acquisition targets are you looking at? And what are your criteria for kind of viewing them?

Yes. So we still consider ourselves a consolidator and will be kind of available. We have certainly the capital both on the equity side and on the debt side and on the cash position to do -- continue down that path. We are -- Matt, it has to meet 2 criteria. It has to meet strategic criteria and it has to meet a financial criteria. And going back to 2019, there were certain assets that were out there that strategically made a ton of sense, financially, we couldn't get to. And we tried to be very rational and smart with our shareholders' money and make sure we get a good return on our investments. And so we haven't been as active as we've been going back 6 or 7 years, but I see as the future, we will continue down that path. We certainly have, as you know, we have the cash position, we have the leverage position, we have the equity position to do that, so -- and over the past few years, speaking of the leverage market, we have been able to both push out the tenor of the debt for a few years as well as get into term loans and get into other types of debt structures, gives us kind of a lot of different good options. We have the ABL, we just redid in November. We have the high-yield market, which has always been available to us, and we also have the term loan market, which is new to us.

Yes. No, your leverage is kind of as low as it's been in a long, long time. So I think that kind of what is your -- I think I'm not supposed to say this as a debt guy, but you seem like you might be a little bit under-levered. So where do you kind of want to see leverage headed? Where are you comfortable at for the longer term? Where are you comfortable taking leverage for the right M&A opportunity?

Yes, Matt, it's Eric again. I'll take a stab at this one. I think historically, as Mike and I have spoken and the leadership team has spoken here, we've kind of targeted a leverage ratio of around 3 or below 3. Obviously, with our strong cash flow this year, I think we're going to close the year probably sub 2. But to your point, is that too low? We're keeping our cash on hand. We're going to be opportunistic going forward, balancing the different things, different capital decisions to make. Certainly, the history of Clean Harbors has been an acquisitive one. And I think that would be a primary option for us to go that route and find a good acquisition in our swim lane. Thinking about leverage in light of an acquisition, I think I mentioned that targeted 3 turns of leverage. I think if we had a good opportunity, we'd probably go above that. And with the eyes towards bringing that back down to kind of the 3 level over a reasonable period of time. So to answer your question, kind of 3 is where we like to be. But certainly, with the right opportunity, we could go above that level.

Okay. Great. You guys got a little bit of assistance from the U.S. and Canadian governments this year that you brought that up on the recent earnings calls. Can you -- do you have any more -- is there any more sort of plan for 2020 and perhaps beyond that you're expecting?

Yes. Well, in 2020, and just -- to maybe just add a little color and be clear because there's really 2 pieces of monies that we received. Thus far through Q3, we've received about $36 million of government subsidies from both kind of the CARES program in the U.S. as well as programs in Canada. So in total, $36 million there. That is a subsidy. We do not have to repay that. It was largely designed to offset some of our payroll expense during the pandemic here on both sides of the border. Also the same number here, $36 million, we've also received that benefit in regards to savings in the U.S., whereby we have not had to remit some portion of our payroll taxes. Now this $36 million, we will have to repay at the end of 2021 as well as 2022. So some cash flow headwinds going forward. So that's what we we've gotten so far, if you will. If you go back to the subsidies that I mentioned a minute ago, $36 million through Q3, we anticipate that perhaps as it relates to the Canadian programs, we may see a couple more million here in Q4 of 2020. Again, as I turn the calendar into 2021, on the Canadian side, again, perhaps a couple of million. On the U.S. side, things aren't as clear. Obviously, with the new administration coming in and a lot of talk about new programs and new stimuluses, we're pretty much maxed out on the U.S. side under the current programs. But if something else is introduced, there may be some money there in 2021. But right now, we're not really forecasting or budgeting anything meaningful.

Just to be clear, what are the amounts that you have to pay back? And what are the timing on those amounts in '21 and '22?

Yes. So it's a total of $36 million approximately. We pay back $18 million of it, so half of it in December of 2021, and the other $18 million is due in December of 2022. And that's all back to the U.S. government, really just some deferred payroll taxes.

Okay. Great. That's helpful. So you've also done a lot of -- made a lot of efforts on reducing costs this year, both in your sort of cost of goods sold, SG&A kind of across the board. And you sort of helped protect margins pretty well as a result. Can you go over just remind people kind of the scope of the program you undertook this year and how you think you can sort of carry those initiatives into 2021? Maybe any cost you kind of have to give back as we head into a recovery?

Yes, Matt, this is Mike. So I would say that we -- when this hit -- when the pandemic hit, March, back half of March, April, May. I mean we were -- like every other company, very concerned. We were worried about shutdowns and lockdowns and you kind of drive around the highways, and there's no other cars, and there's no one really going to work, and it's really -- it was very concerning. And we did some actions that were, looking at our cost structure, I would say, kind of well beyond our peers. I would say that whether it be headcount reductions or lease consolidations or pushing back on vendors or using internal labor or internal trends, subcontractors, temporary labor, all those things were kind of on the table and cut dramatically. And I don't think -- and we learned -- and using things like labor utilization analysis and adding those type, making sure we have the right headcount at the right locations and those types of things that were already in place, but we just got jump-started and got much more highlighted, given the fact that we were all concerned about the potential impact of the pandemic and the effect on Clean Harbors. So with that, we -- that really, in my mind, as we go into 2021, it's going to be a huge benefit for us because I don't see the kind of lessons we've learned, I don't see us kind of coming back and bringing everyone back and come on back in, and let's go hire a bunch of contractors and a bunch of -- open up a whole new bunch of leases. I just don't see that happening. I think we're going to be very smart about that. And so I'm of the view that as we look at 2021, we're going to have -- even if revenue doesn't come back to 2019 levels, which I don't think it will, I think the profitability will be there because I think that the cost savings that we put in place, whether it be around labor, whether it be around asset leases and rentals, all those things are -- we're going to be smart about bringing that stuff back and only bring it back, if we absolutely have to, when the revenue is there to support it. So I'm really very bullish about 2021 in our ability to kind of -- to be aggressive on our cost structure and those cost savings carry into 2021. And as we get to -- we're in the middle of our budget process right now, we're going through different passes like we normally do and we see that. We see that in the numbers.

Okay. No, that's very helpful. Like you alluded to earlier, you've done a great job of refinancing. You pushed out maturities last year. So on the bond side, you're, I think, '27 and '29, so nothing for a while. Your term loan matures in 2024, but that's pretty cheap, I think. So I guess, where does the balance sheet go from here? I mean, you kind of are in a good spot. What's your -- what's the kind of itch that you have to scratch as a CFO to kind of take that next step for your balance sheet or sort of is standing pat a good option at this point?

Yes, Matt, Eric. This is Eric. I'll take that one even though I'm not the CFO, but as you alluded to, I think we're pretty happy with our current portfolio. It's well staggered. It's a nice mix of kind of term loan and high-yield. We do have the ability to pay down some debt specific to the term loan if we wanted to. As I alluded to before, I mean, I think when we weigh our different avenues and different capital outlets, I do think an acquisition, given the low-cost of our debt right now is where we would rather put some capital for the time being, if we saw the right opportunity. So I don't know if standing pat is the right way to describe it, but we do have a very attractive portfolio, a well-rounded portfolio. And in terms of historical context, pretty cheap at a total combined cost of well below 5%. So standing pat for the time being, I think, but every month and every quarter, we kind of reevaluate where we want to put our capital and try to make the best decisions.

All right. You're sort of Ba2/BB+ at this point, do you have any interest in attaining investment grade ratings?

Yes. It's a topic that Mike and I have spent a lot of time talking with certainly the rating agencies as well as certain banks in our portfolio. I might describe investment-grade as a long-term aspirational goal of, I think, any finance team. But as of today, I think we just don't see a whole lot of bang for our buck to go in that direction. We still see ourselves as a growth company and to try to maintain a leverage of under 2 and keep it there, may not coincide with that. The -- although aspirational, I do think where we are right now is good. I don't think we're going to get much better covenants. I think we have pretty much a covenant-lite structure with our current debt agreements. So it is something we talk about. But I don't think it's an absolute top priority right now.

Yes. And honestly, Matt, I don't think it gets -- we don't get a lot for it, right? I mean because the idea about being investment-grade other than it's a really cool thing to put on a resume, it doesn't really, I mean, getting access to commercial paper, maybe slightly lower interest rate, maybe access to a few more types of debt holders, we don't have a huge problem trying to find people interested in Clean Harbor's debt. So I don't see the need to kind of get to that level other than, as Eric said, it's an aspirational goal because I don't think that we get a lot for it, right? Our debt right now is cov-lite structure, and we like it that way. And so it's essentially -- that's a great type of covenant structure.

No, it's a very fair point. Staying on the capital allocation front, how do you balance your desire for low leverage and potential dry powder for M&A opportunities with shareholders who may want you to kind of increase buybacks or maybe start to pay a dividend. Can you just give us your thoughts there?

Yes. So the good news is that we're going to end the year at $550 million, $600 million in cash on the balance sheet. We're going to generate $250 million of free cash flow this year. We're going to generate north of $200 million in 2021, even with the $18 million paybacks that Eric mentioned, and we'll go from there. And my view is that we can do M&A. We can do buybacks. We can do a lot of interesting things, and there's no -- there's really -- and the beautiful thing is that we have a high yield debt. We have term loan debt. We have the ABL we just redid in November, and we have a lot of optionality here. And so I think that we can kind of go in many different directions. And the good news is we'll have the cash flow to do maybe all of it. And so I agree with you that some investors want us to do heavy buybacks or even get into a dividend, which seems a little long answer to that one, but I think we can do M&A and do a fair amount of buyback. I do think there's value in all those decisions.

Okay. Great. I think we're about a minute. I think we're about a minute over the time...

It really depends, Matt, on the ROIC. It really comes down -- we have made return on invested capital, a critical, critical component of our incentive compensation. It's a term we talk about regularly here within the walls of Clean Harbors and every decision we make, whether it be capital -- CapEx and building new incinerators or adding to new incinerators or landfills or buybacks or M&A, it's all done in the lens of what we can get for the best return to the shareholders on this call.

Got it. That's a good answer, good way to sum it up, and I think we're a couple of minutes over the time. So I think we'll wrap it up as well. So it's been a pleasure speaking with you guys this morning. Please hope you all join me in thanking Mike and Eric from Clean Harbors. Thank you for continuing to support our conference, and we'll hopefully speak to you all soon.

Matt, thanks for your time. And thanks for the BAML team to have us on. It's a pleasure.