Stericycle (NASDAQ:SRCL) was also a top detractor during the second quarter. Stericycle’s early-year bounce reversed itself and then some after management lowered forward earnings expectations for the second time in three quarters. Management noted further weakness in their small (~3% of revenues, we estimate), industrial hazardous waste business, and pushed the timeline of about $20 million of expected synergies from their newly acquired document destruction business into next year. Taken alone, we think the stock’s -21% reaction following the earnings release was an overreaction.
We think Stericycle’s core business of regulated waste management continues to be very attractive, throwing off strong free cash flow, with historically steady results. The Company has consistently reinvested these cash flows into smaller, regulated waste management acquisitions, as well as entering new verticals. Secure document destruction is a relatively new vertical for the Company, but we think the demand characteristics (driven by regulatory requirements) and hub -and-spoke collection and disposal model should fit well over the long term. While management noted a longer than expected timeline for converting on-site processing into off-site processing (similar to the way that medical waste is handled), we expect the Company will be successful in this conversion. As for the Company’s industrial hazardous waste business, it has proven to be highly cyclical. However, we expect the benefits of the Company’s overall hazardous waste platform (acquired in 2014) to more than outweigh the risks, as we estimate that retail and medical hazardous waste have grown to over 5% of revenues, from close to zero in 2014 – more than offsetting industrial waste declines. So while we understand investors’ concerns over the Company’s near-term earnings disappointments, we continue to be patient because we think Stericycle’s long-term opportunity for double-digit growth is intact as returns on reinvestment take hold.
From David Rolfe (Trades, Portfolio)'s second quarter 2016 Wedgewood Partners Client Letter.
