Montrose Environmental: Attractive business model; Growth Potential (NYSE:MEG)

Abstract

I recommend buying Montrose Environmental (NYSE:MEG). Entering the environmental protection industry is challenging due to complex regulations and a fragmented market. As a result, customers are looking for green solution providers that can solve problems in their entirety life cycle and in different jurisdictions. MEG aims to target oversaturated markets with many competitors, many of whom specialize in a particular niche or regulations. MEG has an advantage in being able to attract and retain clients and develop relationships due to its global reach and diverse offering. When competing for large accounts that require a national level service provider, MEG excels in its ability to offer unified, geographically dispersed services and a single point of contact for all client needs.

Company overview

Environmental testing and air quality testing are among the services MEG provides. The company’s clientele includes waste management centers, power plants, water treatment plants, municipal governments and multinational corporations worldwide.

The environmental protection industry is a tough nut to crack

The environmental sector is large, expanding, fragmented and subject to intricate regulation. Demand for environmental services is driven by the need to comply with regulations at all levels.

As stated in the MEG S-1, its target markets are saturated with thousands of competing companies. Many larger companies offer limited environmental services as an afterthought to their primary business. However, most companies operating in this sector are small and specialize in serving a narrow set of markets or complying with a narrow set of regulations. Given the technical knowledge, accreditations and licenses required to serve a wide range of clients and industries across geographies and service lines, I believe there is a structural barrier for small businesses to expand. As a result of these factors, entry into the MEG industry is extremely difficult.

I believe customers will place greater value on large green solutions providers as they look for effective, individualized ways to reduce their environmental impact. Particularly for companies and organizations that are present in multiple jurisdictions subject to complex regulatory frameworks, providers that can address the entire lifecycle of environmental issues and requirements will retain a competitive advantage (ie, MEG).

In addition, the need and demand for environmental services has increased as a result of increasing public awareness and stakeholder demands for environmental sustainability. The impact of business on the environment has become an integral part of consideration thanks to the widespread acceptance of CSR and ESG programs. Rather than focusing solely on ensuring compliance, as has been done in the past, these efforts are focused on proactively managing emerging threats.

Demand for environmental services is driven by a number of other factors, including sustained growth in industrial activity and investment in infrastructure and related regulations. Further driving demand are disruptions to the natural environment caused by things like climate change and infrastructure degeneration.

MEG, all in one place with significant global reach

With the addition of new offerings, MEG can now better meet all of its customers’ demands for environmental services. For example, MEG can conduct environmental assessments, obtain necessary permits, and conduct necessary testing in preparation for any remediation projects. Some remediation providers, such as engineering providers, may not have their own testing capabilities and instead contract with an outside vendor.

In addition, MEG has a global reach. I think MEG’s ability to offer unique, geographically dispersed service offerings is highly valued by the clientele. MEG’s strategic mergers and acquisitions have given the company the size it needs to compete and complete projects around the world. The company’s international reach helps MEG acquire new customers and meet the needs of its existing clientele. In my view, MEG’s reach and comprehensive portfolio of offerings puts it in a good position to attract new clients, retain existing ones and develop existing relationships as more and more customers look for environmental solutions providers that can solve their problems across the lifecycle and across multiple jurisdictions.

Overall, I think the ability to provide a single point of contact for all of a client’s needs is a major selling point when competing for large accounts that require a national level service provider. From the perspective of a large customer, it is simpler to work with one supplier than with a set of solutions that may or may not be compatible with each other. When we’re talking about multi-million dollar projects that will take years to complete, the difference becomes even more obvious.

A long-term and diverse client base reduces business risk

MEG has worked with many Fortune 1000 companies and government agencies for years, and they are just a few of the more than 5,300 clients they currently serve. MEG’s revenues are also spread across numerous projects and areas, with a large customer base. In addition, the annual number of projects that MEG completes for these clients ranges from one to several dozen. Moreover, MEG’s financial success does not depend on the spending of a single client. MEG also serves a large number of industries and organizations. As a result, MEG’s business is not heavily dependent on any one industry, which I believe makes it more resilient to downturns in that industry.

The business model is attractive

I think the fact that MEG’s profits are relatively immune to changes in policy is one of the company’s biggest selling points. One of the reasons for this is that it does not rely on any set of regulations to operate. Also, MEG operates in a number of different regions and assists clients in meeting the requirements of different sets of regulations. Therefore, the MEG is usually protected from significant changes in legislation. Although the federal government sets some basic requirements, many state, provincial and municipal laws are even stricter. As a consequence, state, provincial and municipal governments often outline procedures to be followed in order to achieve or implement environmental standards. Policy changes are less likely to occur and have less impact when different branches of government work together.

In my view, MEG’s ability to weather economic storms is strengthened by the breadth and depth of its service offerings and the diversity of industries it serves. It is important to remember that regardless of economic cycles, different industries may experience peak customer activity at different times. Additionally, many of MEG’s service offerings tend to be non-discretionary, and projects often generate clients of significant value, further encouraging continued use of MEG’s services.

Growth opportunities from mergers and acquisitions

MEG’s growth has been phenomenal thanks in large part to its policy of aggressive expansion through acquisitions; the company has acquired over 50 companies since its inception. To expand its service offerings and geographic presence, MEG typically seeks acquisition targets with strong management teams that can introduce innovative new technologies and processes. Since MEG competes in a number of niche markets, I predict the company will maintain its acquisitive nature.

3Q22 results are on track

MEG announced financial results for 3Q22 that were in line with expectations. It is important to note that MEG’s PFAS-contaminated water treatment, renewable energy generation and greenhouse gas measurement services continued to be in high demand. Additionally, MEG has not changed its FY22 revenue guidance, which remains at $535-555 million with an adjusted EBITDA margin of $68-73 million. I was also reassured by the company’s commentary, which indicated that the company has been successful with its price increases and predicts that the sequential improvement in quarterly margins will continue in 4Q12.

Value

I believe MEG is 21% plus. I expect MEG to continue to grow revenue at historical core revenue growth rates (high single digits) driven by the ongoing secular trend. Also, MEG should continue to increase margins consecutively every year to further optimize its cost base and achieve management’s long-term target (20%).

Unfortunately, we missed the first wave of growth due to the change in valuation. MEG is currently trading at a historical average of 22x forward EBITDA and I don’t expect that to change.

risks

Mergers and acquisitions risk

MEG’s growth has been largely driven by acquisitions, and I believe that trend will continue. It is possible that MEG’s future growth rate will be lower than the historical trend if the company does not complete as many deals. It is also possible that revenue and cost synergies will be less than expected if MEG is unable to successfully integrate the acquired businesses. A high rate of mergers and acquisitions can also make it difficult for a company to establish a consistent culture.

It is difficult for investors to value MEG

To succeed in the markets it serves, Montrose must compete with larger companies that offer similar services while offering more comprehensive solutions than its smaller regional competitors. Without a direct public competitor, it may be more difficult for investors to gauge MEG’s performance relative to the market.

Conclusion

Complex regulations and a fragmented market make it difficult to break into the environmental protection industry. As such, companies are looking for environmental service providers who can solve problems across a wide range of sectors and geographies. Due to its global presence and extensive service catalog, MEG is better positioned to win new business, keep existing customers happy and nurture existing partnerships.