Harsco Seeing A 1-2 Punch Of Softening Steel Volumes And Weak Waste Treatment Margins

Very little has gone right for Harsco (NYSE:HSC) in 2022, as the company’s steel services business has seen weakening volumes and the Clean Earth waste treatment business has crumpled under the weight of cost inflation (also an issue in the steel services business). On top of that, there’s little visibility at this point on the sale of the Rail Services business, which management has been treating as a discontinued operation.

I was concerned about the possibility of further margin struggles at Clean Earth back in March, and the shares have lost about half their value since then. There aren’t really any comps for the company, but I would note that Alcoa (AA) and U.S. Steel (X) have seen similar declines over that period, and the waste management space hasn’t been especially strong either.

At this point, I’m torn between a difficult outlook for the steel industry, a more challenged outlook for the economy in general, the company’s self-help initiatives, and the valuation. The shares do appear undervalued on what I think are conservative expectations, but it’s hard to have much confidence in a bullish call here.

 

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Harsco Seeing A 1-2 Punch Of Softening Steel Volumes And Weak Waste Treatment Margins

Harsco Hit Hard On Weaker Growth And Margins

 

Even allowing for some areas of concern that I mentioned in my last article on Harsco (HSC), namely peaking steel production and lackluster results to date in the Clean Earth segment, Harsco’s performance has been quite disappointing. Management makes a decent case that business is better than it appears, but the reality is that numbers have continued to head lower and it’s harder to make the case for a low-margin industrial services business with a lot of debt and a poor track record of free cash flow production.

These shares are down about a third since my last article, and I clearly underestimated the near-term challenges in front of the business. While I certainly think you can argue that current valuation is “undemanding” and that there are some legitimate drivers for the business, a lack of growth and operating leverage in the near term could make outperformance more difficult.

 

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Harsco Hit Hard On Weaker Growth And Margins

Harsco's Business Is Picking Up, But The Stock Price Isn't

 

The broad economic recovery is doing good things for Harsco’s (HSC) numbers, but the number that most shareholders care most about, the share price, isn’t seeing the same benefit yet. The shares are up since my last article on the company, but the 6% rise lags that of the S&P 500 and the broader industrial sector.

I remain modestly concerned that the Street is going to treat this like a short-cycle stock, and I note that the trading action of the shares on a year-to-date basis resembles that of Kennametal (KMT), Parker Hannifin (PH), and Sandvik (SDVKY) – stocks where there is an established historical pattern of institutional rotation away when the manufacturing PMI exceeds 55.

I don’t think Harsco should trade that way. While I do see some risk that the Environmental business is at or near a peak, it could turn out to be more of a plateau as strong demand keeps steel mills busier for longer. With Clean Earth and Rail, I think there are still more significant improvements in underlying business to come. If Harsco can generate a long-term revenue growth rate around 5%-6% and get FCF margins up into the high single-digits, I see near-term upside into the low-$20’s and high single-digit long-term annualized returns after that.

 

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Harsco's Business Is Picking Up, But The Stock Price Isn't

Harsco's Recovery Is Delayed, Not Canceled

My bullish thesis on Harsco (HSC) in August of 2020 was basically a macro-econ call – as the global economy got back underway, steel utilization would pick up (driving demand in Environmental), hazardous waste streams would recover (driving Clean Earth), and deferred transit rail maintenance would eventually get done.

That all worked pretty well up until the fourth quarter earnings report, as the shares were actually outperforming Parker-Hannifin (PH) and Kennametal (KMT) since my last update. Now, these are very different companies, but they tend to do well as early-cycle recovery plays, so that’s why I mention them. After earnings, though, and management’s weak guide for ’21, the stock got beaten down and the return since my last article has more or less tracked the broader industrial space – not bad (up 28%), and definitely better than the S&P 500 (up 13%), but not quite what I hoped to see.

I believe this story can still provide some delayed gratification, and I think the long-term potential of the Environmental and Clean Earth businesses is attractive. I think Rail would be better in somebody else’s hands, but I would expect management to hold on until better performance can support a better sale multiple.

 

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Harsco's Recovery Is Delayed, Not Canceled

Softer Steel Markets Hitting Harsco

Harsco (HSC) didn’t have a great second quarter with respect to reported results or guidance, but I believe the 35% decline over the last three months has more to do with the ongoing weakness in the steel industry – the source of around two-thirds of Harsco’s revenue. Acquiring Clean Earth from Compass (CODI) should reduce some of the cyclicality of Harsco’s business, and Rail still has opportunities to do better, but it’s going to be tough to get the Street excited about a business tied to steel when steel stocks are themselves so weak.

Even with weaker near-term expectations, Harsco's shares look undervalued and the current set-up looks pretty good relative to where the shares have traded over the past year. I do have some concerns that the steel business could weaken further (largely on global macro weakness), but businesses like Clean Earth have gotten robust valuations from the Street in years past and even a more cautious set of expectations can support a share price in the $20s.

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Softer Steel Markets Hitting Harsco

Harsco Shifting From Turnaround To Transformation

Harsco (HSC) is a case-in-point as to why I say that successful turnarounds can exceed your expectations at the start of the turnaround, as management has done a great job of improving its core Metals & Minerals business and it seems as though some of the changes made to the Rail business are about to start paying off. On top of that, Harsco benefited from lucky timing (always a good thing in a turnaround) with the global recovery in steel production and in markets like oil/gas (for its heat exchangers).

Now management is underway with a transformation process that is seeing the company become less of a multi-industrial hodgepodge and more of a focused player in industrial-environmental markets like waste reclamation and treatment. Although the bigger move into waste treatment carries some operational risk, I believe management has earned the benefit of the doubt with respect to its ability to execute.

As for the shares, even with this recent sell-off, the shares are up about 10% from the time of my last article. I saw high $20’s to low $30’s value then, and I still see that now, and a return to the low $20’s in a broader market sell-off would be an opportunity to consider.

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Harsco Shifting From Turnaround To Transformation

Harsco Executing Very Well Amid Healthy Market Trends

Looking into 2019, it’s hard not to like where Harsco (HSC) is sitting. Although steel stocks have sold off on worries that prices and spreads are past the peak, volume and capacity utilization continues to rise, and companies aren’t talking about cutting back on production yet; in fact, there are capacity expansion plans on the books. What’s more, railroads are back to getting back to their maintenance spending, and the current demand/price environment for natural gas suggests a healthy outlook for heat exchangers used to process gas for transport. As far as looming negatives go, nickel prices are a concern, but that’s about the only issue I see right now.

Harsco shares have corrected pretty sharply from their recent November highs, and I think the ongoing weakness in nickel prices (and worries about the steel sector in general) may be why. Although the stock doesn’t look particularly cheap on cash flow, the EV/EBITDA valuation is a little more interesting and management’s apparent intention to shift towards more environmental mitigation in the metals business could drive better sustained margins in the future.

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Harsco Executing Very Well Amid Healthy Market Trends

Multiple Tailwinds Filling The Sails For Chart Industries

Chart Industries (GTLS) has been through some tough times in its past, but the outlook today is much brighter as multiple tailwinds come together to push results, estimates, and the share price higher. The shares have more than doubled over the past year, and climbed close to 60% just on a year-to-date basis, as the company continues to see strong demand from gas processing, vehicle fueling, industrial gas, and newer opportunities like space vehicles.

Chart Industries has significant untapped potential operating leverage and the double-digit revenue growth I expect over the next few years should push margins into the double-digits. Better still, LNG liquefaction orders remain a very significant potential positive driver in the coming years as global LNG demand continues to rise. That said, today’s price does assume quite a lot of growth already and this is more of a momentum-based story driven by the ongoing top-line outperformance and growing order book.

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Multiple Tailwinds Filling The Sails For Chart Industries

Alfa Laval Flexing Its Late-Cycle Muscles

I liked Sweden’s Alfa Laval (OTCPK:ALFVY) (ALFA.ST) earlier this year as a late-cycle play on stronger Marine and Energy orders, as well as decent prospects for ongoing growth in the Food/Water business. Much of that has come to pass, and the shares are now about 20% higher than they were at the time of that last article. Alfa Laval has since logged two very strong quarters, and those hoped-for improvements in the company’s three main business lines have materialized with stronger revenue, orders, and margins.

With the strong move in Alfa Laval’s share price, not to mention some growing concerns about how much is left in this current industrial upswing, I believe these shares have moved from good idea to okay idea. The implied long-term return is still in the high-single digits, which isn’t bad, and I won’t be too surprised if the company has at least one more better-than-expected quarter up its sleeve. Still, I wouldn’t push my luck too far, even though I regard this as a well-managed operator in some attractive businesses.

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Alfa Laval Flexing Its Late-Cycle Muscles

Harsco Back On Offense

Harsco’s (HSC) management deserves a lot of credit for the turnaround efforts that have brought the company’s metal waste processing and reclamation business back into solid profitability, and the market has given them a lot of the credit. Now management is confident enough in the business to begin expanding it again, and the company’s acquisition of Altek moves the company into the aluminum waste processing business – a logical expansion into a large adjacent market. While the company did indeed pay up for this opportunity, the returns as the company rolls out a new platform technology should make this a good deal for shareholders down the road.

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Harsco Back On Offense

Harsco's Restructuring And Improving Commodity Markets Have Boosted Results

It has been a painful process, but Harsco's (HSC) share price is almost back to where it was five years ago and up sharply from sub-$4 lows two years back from today. Much better operating conditions for Harsco's steel mill customers have certainly helped, and the shares have somewhat mirrored steel producers like U.S. Steel (X) and ArcelorMittal (MT) over the last two years, but I wouldn't undersell the company's committed efforts to exit bad contracts and restructure the business for better margins.

Now Harsco is looking at a healthy (albeit probably peaking) steel sector and significant recovery growth in heat exchanger demand. The Rail business isn't doing particularly well, but that is not so surprising and remains a long-term project. Valuation is tricky, as I'll discuss later, but I believe you could make a relative valuation argument to support a higher share price from here.

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Harsco's Restructuring And Improving Commodity Markets Have Boosted Results

Harsco Reaping The Benefits Of Restructuring, Even As Energy Markets Remain Tough

Credit where due – Harsco's (HSC) management continues to deliver on its turnaround plans and this multi-armed industrial company is now looking toward growth again in a few of its businesses. I underestimated the upside that was still left in these shares a year ago; while I thought a fair value in the mid-to-high teens was possible if the company executed well, I didn't think shareholders would get a 50% return in such a relatively short time. Granted, some of that upside has come from the overall market melt-up, but I do believe Harsco has outperformed its targets.

What comes next has a lot to do with macro factors that are outside of management's control. I still believe that traditional steel mills in North America and Western Europe don't have a bright long-term future, but conditions have improved in the near term and Harsco has been turning its attention to other markets like China. What's more, there are opportunities to expand this business, as well as expand and diversify the Industrial segment and drive better margins from the Rail operations. I wouldn't expect another 50% move over the next twelve months, but so far Harsco is proving the point that well-constructed turnaround plans can exceed initial expectations, and particularly so when improving end-markets help the cause.

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Harsco Reaping The Benefits Of Restructuring, Even As Energy Markets Remain Tough

Harsco's Paddling Hard, But The Currents Are Unforgiving

It has been a while since I've written on Harsco (NYSE:HSC), as I wasn't all that interested in the company's seemingly endless attempt to turn itself around while under the shadow of significant debt, ongoing overcapacity in global steel and weak conditions in its core markets, and the ongoing slide in the energy sector. With that, the shares are about a third lower than when I wrote that last piece, though the point of "peak pain" saw a roughly 75% move down.

Management at Harsco deserves some credit. Project Orion has made the Metals and Minerals business better, with a lower cost structure and a more aggressive approach to maximizing value. Alas, I do worry that this is a little like painting flames on the side of a mobility scooter - the business is better, but it is still serving an industry that is going to struggle to grow. What's more, the Rail business that was supposed to be the source of strength has had its own ups and downs and the Industrial business remains exposed to weak energy markets.

If a lot of things go right for Harsco, I can see a fair value in the $16 to $18 range as being valid, but that's going to require ongoing improvement (and no backsliding) in the M&M business, good execution in rail, and an energy recovery. In my base-case, though, the shares look more fairly valued. Harsco has done what it can to be better, but sometimes that's just not quite enough.

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Harsco's Paddling Hard, But The Currents Are Unforgiving

Seeking Alpha: Sluggish Markets Dragging Out Harsco's Recovery

I don't want to be flippant about it, but it seems hard to remember a time when Harsco (NYSE:HSC) wasn't a recovery/turnaround story. The company has been working for years to improve its Metals and Minerals business, and management has taken several logical steps to exit or improve underperforming contracts, but it is hard to make progress fixing a steel mill services business when the steel mills themselves are struggling.

I'm not completely certain that Harsco can get back to a point where it earns a return on capital in excess of its cost of equity capital, but it's going to take several years to find out. You could argue that Harsco is undervalued, particularly on an EV/EBITDA basis, but I believe it is going to take a meaningful recovery in steel mill utilization to drive that recovery and I don't see that as especially likely in the near term.

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Sluggish Markets Dragging Out Harsco's Recovery

Seeking Alpha: Harsco Has A Long Road, But A Better Plan

I wasn't sold on Harsco's (NYSE:HSC) recovery plans around eight months ago, or at least the extent to which the valuation on the shares already assumed a lot of improvement. The shares have been volatile since then, declining almost 20%, before a recent recovery run has taken them back to basically flat. I'm more optimistic about the company's plan and outlook today, but the valuation is still not compelling enough to me.

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Harsco Has A Long Road, But A Better Plan

Seeking Alpha: Harsco Already Getting Some Benefit Of The Doubt

It has been a rough road for Harsco (HSC) over the last two years. While the stock has rebounded some already (up about one-third from its mid-November 2012 lows) on hopes that better days are ahead, the company's sluggish-to-poor revenue, margin, and free cash flow performance since 2009 reflect the challenges in both the global steel market and infrastructure/construction markets.

I do think better days could be on the way. Steel mill utilization in Europe seems to be past its trough and Harsco has been actively turning its focus toward emerging markets. At the same time, management found a good home for the Infrastructure business and has the opportunity to leverage its Industrial and Rail businesses into larger contributors. I have some concerns that the market has been too quick to assume that Harsco's turnaround plans will work (we've heard it before from this company), but I can't argue that a recovery could ultimately take these shares into the $40s down the line.

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Harsco Already Getting Some Benefit Of The Doubt

Investopedia: Harsco Could Be Troughing

These have been challenging times for industrial conglomerate Harsco (NYSE:HSC). Weak demand for commercial construction and weak funding for infrastructure projects has hurt the company's infrastructure business, while a weak market for European steelmakers has likewise hurt the mill services business. Calling a bottom in non-residential construction or steel is a fool's errand, but odds favor these markets getting better over the next year or two and a new CEO could reverse a disappointing record regarding cash flow generation and asset efficiency.

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