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

Good morning. This is Michael Hoffman from Stifel. I'm the Group Head of Diversified Industrial Research. I cover solid industrial medical waste, pest control and specialty distribution. Welcome to day 2 of CSI. It's my pleasure to welcome Clean Harbors, and we have with us Mike Battles, who's the Chief Financial Officer; and Brian Weber, who is the Chief Development Officer. Mike Battles, I think Jim might be off in the side there. So Jim Buckley is with us, but off-screen. So welcome, and thank you for being with us today.

Michael, thanks for having us, and the team at Stifel. It's always a pleasure to talk to you and to the investors.

So let's lead off with a high-level comment because we've had a couple industrial companies already on day 1. How would you frame the outlook for the North American industrial economic revival? What's your opinion of it broadly?

I mean in the world we play in, there's broad recovery. I mean I just feel like whether it's in different parts of our business, whether it's chemical manufacturing or in automotive or other areas, I mean it really is -- there really isn't a loser in the group as far as like where we are -- are all parts back to 2019 levels? No. But are they making good progress toward that end? Absolutely. So the one area I would say that we're still -- the pipeline is great. But the actual results still slow. In the project work -- in the large waste streams that we compete with some of the other companies that you follow, again, pipeline is great, and we don't need many of those to have a really good year, but the actuals are still, let's say, on to come because they're still worried about spending and about timing and so forth.

So they haven't canceled these things. They're just delaying the release of them?

Yes. Knowing that, but we -- we follow that pipeline very carefully. We have a -- we use kind of a software that helps us track as far as completion rates and hit rates and so forth. It seems to be going really well and pipeline is going full. And so that gives us a really good feeling that we're not going to win them all, but we're going to win our fair share and that will be fine.

And then one of the macro concerns is the supply chain disruptions that have been occurring, whether it's ocean freight-related issues or even on land transportation, just the constraints within the model, has any of that surfaced in conversations with the customer base about the possibility of having to slow down because the demand is greater than they can order and get parts in place?

I mean, Michael, we're seeing that in our own business with our waste volumes in our incinerators. We had a large deferred revenue at the end of Q2. We have more waste than we can handle it. And as such, that is -- it's a high-class problem, but it's still a problem, right? I think that, that's going to put pressure on all of us. And we're thinking about supply chain issues, that's putting pressure also on inflation, but we can't hire enough people, which has always been a problem, right? But it's more acute now for reasons I don't want to get into. So we are struggling to kind of get kind of the right people in the right places, and it's been more acute now. And as we talked about before, whether it be insurance or benefits or other third-party spend, those costs are going up. And the good news is guys like Brian and others have done a great job of managing the cost structure, lowering our cost structure so that we can handle that type, along with the price increases that we'll talk about.

Well, yes, so I guess, I would sort of jump on that. I mean -- and I don't think anybody is sitting here trying to say, "Oh, there's no inflation." There's inflation, I mean it's...

Absolutely.

It's there. Say again?

It's here. It's not on to come. It's like we're seeing it today.

Yes. It's here. But, then the but is, you can, in fact, price through -- so there's a combination of productivity and a combination of price that it means you're not suffering margin compression because of inflation, you're able to address it and address it relatively real time.

That's absolutely right, Michael. As a matter of fact, Alan mentioned on the Q1 call an 8% price increase. That's a little -- that normally we'd go into, but there is a stick rate associated with that. So the actual number from incineration comes down a bit from there. I think the stick rate has been better than it has been historically. And so -- because people you kind of get it. I mean we're not alone in this inflationary pressure that we're feeling. Our customers are feeling it. And so as such, our ability to go get a little more price has been better received than it has been in the past certainly.

Okay. So the other question I'd like to ask about the macro. And this is an opinion we have here at Stifel across the industrial coverage is the nature of this economic recovery, this industrial economic recovery is it appears it's going to have a higher rate of performance longer, meaning instead of progressing to that long-term average of 3% industrial production relatively quickly, it looks like it's gone to hold to a higher rate all through this year into '22. There's even some thought that it might even roll a little bit into '23. So you can see above-average industrial production longer than normal, and then it would hit a settling point. Do you have a feel for or a view of that?

Well, it's a good question. So let's start by saying we haven't modeled that in our guidance. We're assuming that the world gets back to some level of normality relatively quickly. And if that doesn't happen, well, then there's upside to the model. And so it's hard for me to predict that. I'm going to owe for a lifetime of predicting stuff like that. So I'm not going to try to speculate. But I will say that as we've guided, both Q2 and for the year, in the Q1 call, we assume that we get back to normal pretty quickly, both on the oil price spread, which I'm sure we'll talk about, as well as the industrial production and growth rates.

Okay. All right. So let's segue to, you came into this New Year and you reorganized your lines of business. Let's talk a little bit about what drove that reorganization. What's the why behind it? And how would you all measure success of the expected outcomes? And then how would we see that this has been a successful decision to do this?

You want me to take that one, Mike?

Sure, Brian, thanks.

Yes. So it's a great question, Michael. I would say almost it was a culmination of the integration plan that we envisioned when we acquired Safety-Kleen back at the end of 2012. We always kind of felt like the parts washing part of the business, containerized waste, vacuum truck services, the total project management, that stuff is all a perfect fit with our regional environmental services structure, where we get a great opportunity to share people, share equipment, cross-sell and really try to leverage the disposal facility network that we have and then creating a stand-alone organization with dedicated sales and operations people that are just totally focused on the end-to-end value chain around oil just made perfect sense to us. So whether it be collection of used motor oil, the rig refining, the sales of base of blended lubes and all the related products and having kind of a 1,000-plus people organization that's full time focused on that, 150-plus sellers, they just wake up thinking about those lines of business every day was just a natural. So that's a little bit around the rationale for the organizational change. And as we think about what does success look like, I think it's revenue, profit, volume growth across the segments and really continuing, particularly on the Safety-Kleen sustainability side of the house, continuing that healthy spread management.

Okay. So this is -- yes.

One more point, Michael, before we get to asked a follow-up question, is that it's always been -- when you think about SK, it's always been, hey, we're going to do parts washing, containerized waste, and we're going to keep the plants full and make base oil, which has been a very successful strategy to this point. But what Brian is doing, the team under Brian's leadership, is that we're trying to collect more gallons than just to fill the plants because there's opportunities there. So the growth -- I've seen this as a real growth opportunity that there's oil to be collected and if we don't put it in the refiner, well, that's fine. We can sell it as RFO. We can do different things with it that are well beyond just -- because at some juncture, historically, the SK team to their credit, parts washing, containerized waste, vac services, let's maximize that, good margins and book -- and while we're at it, we're going to take the oil and fill the plant and fill the plant and sell it. Great. Now the answer, what the team is doing now is pulling that out, putting some real thought process behind it with the idea that let's collect the right gallons in the right locations, ensure the plants are full, of course, then we'll have extra that we can sell in the open market, and by the way, makes some money there, too, right? And so that's really the concept behind it. That's really -- that's when you just take a step back and think about it, I'm surprised it took us 7 years to get here.

Okay. So that was my cynical question. So what took you so long?

So we want to be very careful not to break the business. The Safety-Kleen is a 50-plus year brand with a great legacy out there. And in their past history, going back 20-plus years, the business had been tinkered with by various ownership groups to the detriment of the overall business. So we wanted to take a slow and cautious approach and make sure we didn't break anything.

Okay. So I think maybe I'm going to skip the Safety-Kleen Sustainability Solutions on the Q&A and come back to Environmental in a second, so we follow this line of thinking. One of the aspects of this is that you are, one, the market leader in both the collection side and the processing side. It's 1 billion some gallons is the addressable market to collect. You've got a couple of hundred million gallons on the front end of processing with a 75% yield on the back end. And I guess, where I'm going with this is, why haven't you and the market -- so you've been more successful, why hasn't the market embraced this where that loop closes better? And particularly sitting here today in 2021, when everybody and their brother is having an ESG conversation, and you and I can remember 3 years ago, I'm in front of your Board and talking about ESG was critical. And you all have realized and come to that awareness as well, but why aren't those big generator -- volume generators of oil that you collect taking it back as a blended product and closing that loop? Because this seems like a huge opportunity.

Yes, I totally agree. And I think we're just on the front end of that now. I think probably we underestimated the sales cycle to be able to convince those big volume accounts to switch to a closed-loop model. But certainly, now with ESG as a backdrop, we're getting more inquiries than we've ever had. And the discussions we're having with those large customers now are more of the kind of Chief Sustainability Officer level than they are with the procurement people. So we're in discussions on a number of bigger volume opportunities right now and getting the kind of audience that we didn't have a couple of years ago. It's -- frankly, it's just taken longer, but we're making progress.

And by isolating this and having a dedicated sales force, and it's a really -- it's a stand-alone. Now you -- somebody is highly accountable for the circularity of this. Does that just change sort of a cultural intensity?

It really does. Yes. I think the 150, give or take, sellers that we have in the field now are all designed to sell kind of the full spectrum, whether it be collecting used motor oil, selling finished lubes, selling recycled antifreeze, they've been trained on how to sell those lines of business. It's fewer lines of business to focus on than what they've had to focus on historically. Their incentive programs are aligned around the closed loop, and we just feel like we've got a really nice opportunity for success here.

All right. So Brian, your other pad is like -- introduced you as Chief Development Officer. And specific to this segment, you have a great geographic presence in the west and then on the northern tier of the country for the refining capacity, but nothing in the Gulf Coast to speak of. I mean it's -- I mean you may have great collection, but you don't -- you got to move it a long way. So is this an opportunity is to go looking for? Or is it a development opportunity to put processing capacity in the Gulf?

Yes. I think it is, Michael. We recognize that that's an area where we actually have healthy collection volumes. But to your exact point, we have to move that volume a long way. There is a decent RFO market in the southeast. And so we can and we do sell excess volume into the RFO market, but some additional re-refining capacity is something that might be helpful in our overall network.

And your big injustice seems to be getting more and more fixated on market shares. But can you make an argument about the regional aspect of this so that if you did find capacity that was available in the market, you can be a buyer and get through a justice process?

We think so. We track over 400 used motor oil collectors. It's a very fragmented market. There's a number of collectors. And we have -- we're the leader in the space, but there's 75% market share that we don't have. And on the re-refining side, we're really just an afterthought, honestly, to the majors, Motiva and Phillips 66 and Chevron. And we're all in the same refining space. And so we don't think there's any competitive threat on the re-refining side either.

Okay. And then one of the players in this marketplace has just made a recent announcement about moving towards buying a refinery and then retrofitting it into renewable diesel. And I'm not asking you to comment on the economics of that or -- but I'm curious about the strategy of it is if you're going to end up controlling a lot more oil, is there an opportunity to look at refineries that do distillates and that have hydrocrackers that therefore could be retrofitted and you could do more volume through them that way? Is that an option?

I would say that we're considering any and all options and want to continue to be opportunistic.

Okay. So I guess the piece that fascinates me. This business when a couple of years ago, 2019 did $80 million worth of EBITDA just -- and before the reorg and I'm assuming the reorg, it's that $80 million is only a little bit better, not worse.

It's $120 million now because of some price sharing between the SK brand. So a normal year would be a $120 million a year, Michael.

Okay. So that $80 million looks like $120 million today?

That's right.

Okay. And we're sitting on silly spreads because of the strength of demand against supply constraints for outages and weather-related issues. And so the interesting question here is, is there a line of sight on rebalancing? Like is that looming quickly? Or is this -- is it elongated? Can you give us a feel for that?

So I would say that the -- certainly, in Q2, it's going to be really good. It's going to be -- like I understand from others is that it's going to -- we're going to have a good Q2 because it's spread so wide for the reasons you just articulated. And the question is, how long does that last? And my answer to that question is that we haven't guided to that. We've assumed that, that spread kind of gets back to normal relatively soon in Q3 and extends, and it's hard for me to speculate as to when plants get fully capacity, they get all the people they need, they get all the -- everything they need to kind of run right to get the spread back to normal. Well, I'm assuming that gets back to normal pretty quickly, and if it doesn't, there would be probably an upside to the model in 2021.

Okay. And then a couple of years ago, we were all having this fixation on IMO 2020 and that happens, and my sense is that IMO 2020 has had an influence. It just didn't create part of the influence because you disrupted the shipping and therefore elongated the period to get the resupply done of fuel. But it has absolutely displaced used oil. Used oil has to find other alternatives because of IMO 2020, is that an accurate statement?

Absolutely. And I think that widespread that we're talking about, the real question is when normal gets back and the refiners get back up and operational, like what is that spread going to be? Right now, it's really wide. We're like, that's great. It's due to all refiners. We've had 4 price increases since December. That's up 30%. That's not normal. This is dislocation due to bad weather and demand and jet fuel and this and that. And the answer is, well, what is normal? Certainly, on the front end of the spread, on the collection side, make no mistake that we are being able to hold the line on price a lot better than we have historically. And part of that reason is because of IMO 2020, absolutely. How much that is? Pennies, dimes, quarters, I don't know, right? But certainly, that is material because you look at kind of where we are now in a charge for oil world versus our base oil price, it doesn't make any sense. It's excellent. And the question is, why is that? Why is -- on the sales side, it's we're market takers. As you know, Michael, we're in that, we take -- as Brian said, we take it whatever it is, it is, that's great. On the front end respect, well, that's still pretty good. And why -- you would think that kind of fixes itself, we talked about a 2-month lag. Why is it longer? Well, I think part of that is IMO. And my point being is that when the world gets back to normal and the plants are running well and things get back to -- I think there's going to be a wide spread for some period of time. And how long that is and for how much? I don't know, but it's not 0. That's for sure.

Okay. And so my -- again, this is the risk of modeling because you can put a whole lot of data into the front end and then it produces something. But it feels like you might -- maybe you get down to something that's pennies, but it feels like charge for oil is here to stay, that this doesn't become a pay for oil issue ever again?

I think it will. I think at some juncture, I don't know when. But as prices continue to rise, there's going to be some dynamics on that. And I agree with you that normally, that moves a couple of months. It kind of moves in lockstep, and that's the spread management we talk about all the time. It's slower now. I think as oil prices continue to increase and crude -- and base oil prices continue to increase, that's going to continue to put some pressure. And remember, we're tying to the price of base oil in some cases. So we will get -- that's -- we're trying to manage our spread and manage our P&L like our customers are. So as such, that price is going to move, right? So I don't -- I envision that if prices continue to rise, there'll be some -- will be in pay for oil world, but nowhere near where we were, let's say, back 2 or 3 years ago.

Okay. So last question on this, and then we'll move to Environmental Services. What's the likelihood that you stop having to take a discount to the posted price if the loop really does close? Is that a legitimate prospect that you -- at a minimum, you could at least eliminate the discount?

I think that ultimately, that it gets better. I think that it's hard to prove something that we're in the early stages of. I'm of the view that people, as the sustainability solution -- we are the sustainability solution for a lot of reasons. We talked about on environmental side, on the ES side, but I think on the SKSS side, too, we're a solution. And as such, we'll be able to charge a premium, not a discount, right? The idea would be that, hey, we were trying to sell that in Michael's auto body shop, and they want to take 5 barrels of oil. We'll give them a price that makes it worth their while to do so. We got to move away from that and talk about value service that we have and get the larger of the guys in the world and get some real margin out of that. I think that the world -- as I said many times, Michael, I really believe at this time, it's -- the world is coming towards us. The world is coming towards us from a state of those.

Well, and just to put that in perspective, that discount can range between 10% to 20% of the posted price, so we're in a $3 posted price these days. That's not a trivial number when you're talking about in total 150 million gallons.

And over the past year, that discount has remained fairly consistent. So as the prices moved up, that discount stays the same, but it's been moving with it. So -- and this demand has kind of squeezed that discount a little bit, but still a discount.

But it's still in that 10 to 20 zone?

I believe so. Yes.

And we really feel like we should be getting a sustainability premium, to Mike's point. I mean the quality of our products is second to none. And we're making them with re-refined oil, and none of the majors can do that. And so we feel like rather than a discount to posted price, we ought to get a premium, we just need to convince the market of that.

And really, our supervisor thinks that we're not doing a good job. We were not getting a premium amount and we get reminded that from time to time.

Yes, sure, Alan has an opinion about that. Well, and what I'm hearing is, you're having a conversation that says, there's something that looks like maybe even a $10 million just getting to no discount, let alone a premium lever.

Absolutely.

Okay. All right...

I would think though -- I think what's going to happen in the short term is that spreads aren't that too wide. We're going to have the benefit of that in 2021. The question for 2022 is, well, how much of that widespread is real and how much can we maintain that by lowering the discount, IMO 2020 and better collection logistics with the new SKSS organization? So our goal is to take this awesome widespread that we're seeing that I think a little unnatural, a little temporary and may get permanent. And that's going to be the question. The debate we're going to have now and end of the month in Vegas and next year, like what is going to be, where are you with that? And that's a challenge we're putting on ourselves. We don't want to have like good, good, oh down, and then good. We want to kind of keep going up.

Yes. Well, and I would say it would be deemed successful if '22 is flat for '21 if it -- if there's a settling?

Absolutely.

That would be a big win as opposed to...

That would be a greenlight -- it won't look that way, it did look flat, like, that's interesting. But given the fact where we are now, and where we will be in Q2 and probably in Q3, Brian and I would be super excited for that.

Okay. All right. So switching gears back to Environmental Services. When you think across the major components, whether it's the drummed waste, the volume in landfill, the incineration, are some of those at or better than '19 and others aren't? And what's that look like as far as where the -- we're still catching up?

Yes. So on the TS side, on the tech service side, Michael, you've seen the quarterly financial statements. You've been following us for long. Nothing happened. It was fine. It continued to grow and do well, and it's like nothing burned. It was -- had a good year, and it did well. The plants ran well, and we had a, I'd say, a relatively normal year. On Field Services, now we had a great year in 2020 because of all the decontamination work. The base business was down 10%, 15%, mostly in utilities because utilities were slowing down. And so we had that bit of a thing. I think we're back up. Here we are in April, May, June, back in '19 -- 2019 level ex the decon. Decon is kind of, as we've said, was dying a death. It died a death, which is a good thing, by the way, which is I'm happy about as a human that we're kind of in the back end of the pandemic and the decon work is less and less, but now, it's a trickle, basically. So that's where we are in the field. So I'd say we're kind of back to normal, normal 2019 and 2019 normal. In waste projects, the project work, as I said earlier, still a little slow. Big pipeline, awesome, but still a little slow. And so that is kind of a little bit of a drag. We knew that. We guided to that. I'm not worried about that. I mean I'm torturing the leadership team there, and there we have a pipeline that says better than ever. On the industrial side, still a little slow. People concerned. It's getting -- they had a good Q2, but not back to awesome, right? And on the SK branch business, miles driven, it's ramping back up really fast. And Q1 was soft, Q2 will be fine and I think that business is -- as you know, I love that business, that's good.

Yes, your favorite thing is to call that an ATM.

I call it ATM machine, which is kind of a misnomer.

Yes. So the industrial piece, is it the true remediation project-type work where -- it's bad or is it you're coming in and doing heat exchanger cleaning or the deep -- the tank bottom clean-outs or the refining turnarounds? What part of that isn't catching up yet?

I think some of the challenges is getting people. I mean we are really struggling with people and hiring people and bringing people in to service that. I'm not saying it's a gate to earnings yet, but certainly, it puts pressure on timing. And it's putting pressure on timing as to when we can do work and how we can get work done. So it has been -- here in Q2, it has been a little bit of a slowdown. But there is -- we're having -- we're going to have a great Q2. I'm not worried about that, but it has been a bit of a damper. And there has been some pushouts, not out of 2021, but into Q3 and Q4, and you know how it works for the industrial, Michael.

Right.

But it get pushed again and all of a sudden, it's in the next year and then...

Yes. But most of those Industrial Services are things that if they don't do them, they're going to artificially shut a plant down.

I understand that, which is the high-margin work, we can get it. So I'm not overly excited about that. But at the same time, what I hear from the Industrial Services guys is that it's not back at the 2019 levels.

And this is more of a skilled workforce. So I'm not sure that that's maybe as sensitive to the government is paying people to stay-at-home risk challenge to unskilled. I hear across lots of my coverage, getting unskilled people back into the workforce has been tough because of the unemployment offsets that exist at the moment. But this is a skilled workforce. So is this just -- there's so many people looking for this type of skilled employee?

I think it's both. I think we take low-level people as well, not totally unskilled, but certainly, we take a wide variety of talent. It's a dirty job, as you know, Michael. It's not for everybody. So it's really been hard to kind of try to retain people. As you also have noted, we put investments in benefits. We -- prior to the pandemic, investment in 401(k) to try to attract. Because I think the challenge is not necessarily attracting people, it's to keep the bucket from leaking, like don't -- like stop the flow of people out of the organization. I think that's a much easier way to maintain headcount versus trying to attract. Michael and Brian can work for us and how great we are to work for. Let's stop losing Jim and Bob out of the organization, and we'll get better that way.

Okay. And then Brian, Alan loves to talk about M&A. And sometimes, I think the market's reaction is always going to go out and do another big deal. And I'm not sure there's big ones. But talk about what the M&A environment looks like for Clean Harbors and -- and not so much the names, the companies, but the types of things that you would like to be -- to see in the market that -- or if it came into the market, you would like to be looking at?

Sure. Yes. I think the pipeline is still pretty robust. Obviously, a lot of pent-up demand flowed into the first quarter of 2021, and we're still seeing good healthy deal flow. Businesses of various sizes and in different geographies. And I think our focus continues to be on the 2 kind of core segments. The sustainability side, we did a small deal in the first quarter where we acquired a UMO collector in Texas. And so still interest in that part of the business. And then certainly on the Field Services, tech service, kind of Environmental Services side, there's opportunities there, regional guys, et cetera, that are on the market that are piquing our interest as well. We're not looking to grow inorganically in the oil and gas field services space, but continuing to look at acquisition opportunities sort of inside of that core.

Okay. And then lastly, you set 5-year goals recently, which I think is terrific to have that confidence to look forward. I was curious, you did at a 1% to 2% growth over GDP, and yet you're really tied to industrial production. So I was -- it was more of a curiosity, why not align it to the industrial production versus GDP from a standpoint of that goal?

We looked at it in a couple of different ways. We looked at it, is it industrial production and vehicle miles driven? Is it is GDP -- I mean GDP kind of capsulated everything. I agree with you, Michael, that if you try to correlate investor production in our business, it correlates a little better than GDP. So I get the point, but we just picked a number that we thought would people kind of get their head around because GDP and capital is everything beyond IP, which includes vehicle miles, which is important to the SK branch business and the SKSS business.

All right. And then the $300 million free cash flow target, can you frame what that looks like as a cash conversion of the -- of a future EBITDA? Where -- I assume you're going to improve the cash conversion.

Yes. I mean, look, we recognize cash conversion is important. We recognize free cash flow per share is an important metric and we bide ourselves and actually been doing a lot better than that over the past few years and getting better at that conversion, and we're up in the high 30% to low 40%. I think that continues. I'm not sure if it gets better. I'm not sure what time horizon, but we recognize the fact that that's an important metric that EBITDA without cash flow is what you got. So you really need both, and you need to bring both of them along with us. And I'm of the view that, that gets in the low 40s and keeps going from there. And I think that -- I think we can do it. I think we've proven to ourselves in the last 2 or 3 years we can do it.

Well, and you have a margin target of 30 to 50 basis points a year. So if you math that out...

That's what happened.

Yes. Then by definition, the cash conversion, either something is leaking or the cash conversion is improving...

That's right.

And if you really did the midpoint of that over that time frame, it argues you're somewhere 45% to 47% of your EBITDA is converting into cash.

That's right. That's what math would say, right?

Right. So then none of that scares you off?

I mean, look, we have done a great job over the past 4 or 5 years, led by guys like Brian and others to really drive this business forward, focusing on ROIC, focusing on cost controls, focusing on high-value waste streams, looking at opportunities like decon, I mean, has been great. And so why would you think that, that doesn't continue? Like we got the memo. Stock's at an all-time high, like we got rewarded for doing smart things. So why would we not continue to do smart things. I like to think that we're smart.

No comment. So not surprising, I've run over the time. So we're at the end of our time. I want to thank both of you and Jim in incognito for making time for us today. Look forward to seeing you in a couple of weeks at -- in Vegas at WasteExpo, and have a good rest of the day.

Thanks, Michael. Thanks, Stifel, for their interest in Clean Harbors.

Absolutely.

Thank you very much, Michael. Appreciate it.

Take care, Brian.