We are lowering our rating on Harsco Corp. (NYSE: HSC) to HOLD from BUY, as the shares have surpassed our former target price of $16. The company struggled along with the industrial economy in 2014-2016, though the combination of a new CEO and cost-cutting and business transformation initiatives had led to a turnaround prior to the pandemic. Currently, Harsco’s environmental remediation businesses are being hurt by pandemic-related business shutdowns. Demand is uneven and margins are under pressure. Harsco does not pay a dividend, whereas the industry average yield is 1.2%. We think the low multiples are reasonable given the challenges to the company’s businesses and balance sheet.
On November 3, Harsco reported 3Q revenue of $509 million, up from $423 million in 3Q19. Excluding unusual items, non-GAAP EPS came to a $0.08 per share.
Management looks for continued positive trends in the HSC Environment and Clean Earth segments. However, the Rail segment has not yet shown improvement due to deferred capital spending by both freight and passenger railroads. It expects to maintain current capital spending levels and cost-control discipline for the foreseeable future.
We believe this asset realignment will drive greater operational efficiency and growth over time.
EARNINGS & GROWTH ANALYSIS
The Harsco Environmental segment provides critical services and support for steel production and environmental and zero-waste solutions for manufacturing by-products in the metals industry. The Clean Earth segment processes specialty waste and hazardous and nonhazardous waste. Harsco’s Rail segment provides equipment and services for railroad track maintenance.
The decline was driven by lower demand for environmental services and applied products as a result of the pandemic, partially offset by lower operating expenses.
The increase in revenue reflected contributions from the ESOL acquisition in April 2020, while the margin pressure was due to lower demand for hazardous and contaminated materials services during the pandemic.
In the Rail segment, revenue increased 24%, but EBITDA fell 64%.
Based on the company’s uneven revenue trends, and the resulting pressure on margins, we continue to project 2020 adjusted EPS of $0.44, implying a 50% decline from 2019.
FINANCIAL STRENGTH & DIVIDEND
Free cash flow was positive $18 million in 3Q20, compared to $5 million a year earlier. The improvement in free cash flow was driven by changes in net cash from operating activities, including cash generated from working capital and lower capital expenditures.
MANAGEMENT & RISKS
Nicholas Grasberger became Harsco’s CEO and president in July 2014, and its chairman in October 2018. He had been CFO. Peter Minan became SVP & CFO in November 2014.
Investors in HSC shares face risks. Harsco’s businesses are cyclical, and persistent weakness in some end markets poses a risk to our estimates. In general, risks for Harsco include a downturn in manufacturing and nonresidential construction, higher commodity and energy costs, and a stronger U.S. dollar.
On a fundamental basis, HSC shares are trading at a projected 2021 P/E of 23, below the Industrial sector average of 27. HSC also trades at a price/sales ratio of 0.8, well below the peer average of 1.8. Harsco does not pay a dividend, whereas the industry average yield is 1.2%. We think the low multiples are reasonable given the challenges to the company’s businesses and balance sheet.
On November 20, HOLD-rated HSC closed at $17.01, down $0.10.