The top environmental service companies
- By Sabrina Barker
- Aug 01, 1999
Environmental consulting and engineering firms: How well are they performing?
The last few years have witnessed an explosive surge toward greater consolidation in most sectors of the environmental services industry. Major deals have dramatically rearranged the competitive landscape - the USA Waste/Waste Management merger in the solid waste sector, U.S. Filter's ongoing acquisitions in the water arena and its recent sale to the French giant Vivendi, or Laidlaw's almost-complete attempt to consolidate the hazardous waste arena. In short, the industry is continuing to undergo a rapid reshuffling and a very thorough competitive rearrangement.
At times, the pace of this consolidation can be bewildering, making it difficult to conduct any kind of meaningful strategic planning or competitive analysis. This pace of change will, however, undoubtedly settle down before too long - and out of this turmoil will emerge the leaders of the future. Who are those leaders likely to be, and what characteristics will they have? Here, we have attempted to identify the top-performing companies in the environmental services industry.
Despite all of the difficulties and challenges inherent to the environmental services business, there are still numerous companies turning in consistently strong results that represent a sound investment in the future. Firms that can thrive and prosper in the current difficult environment are likely to be even stronger performers in the more stable and predictable business environment that seems likely to develop in the future.
So, who is the best? Which companies are the top performers in the environmental services industry this year, and which companies hold out the most promise for the future?
First, a few caveats. This type of assessment is difficult to conduct in a conclusive and objective manner - results may be biased by intangible assumptions, a range of vague value judgments or fine differences in data interpretation. Some observers may consider the "best" companies to be those that have grown the most quickly; on the other hand, investors typically place a premium value on those whose stock value is worth the most, or those that have generated the highest profits. Job hunters rank companies in terms of which seem the best to work for, and so on. All of these characteristics are not always found within the same company. In addition, performance inevitably changes over time - last year's top company, by any definition, is not necessarily this year's top company. Will today's top companies be the leaders over the longer term? All of these factors must somehow be taken into account in estimating the top performers.
It is not simple to design a comprehensive and quantitative model that takes all of these factors into account to yield a consensus. However, experience over the years has shown that many of these factors do in fact tend to go hand-in-hand; companies that are more profitable and dynamic usually tend to be fun places to work, and more profitable companies tend to have relatively higher stock values. If the various past surveys conducted by The Environmental Benchmarker and Strategist (TEBS) show any pattern, it is that there is an elite group of companies in this industry that tends to outperform the rest, regardless of the attribute being measured. In fact, our past surveys have tended to isolate the same relatively small group of companies.
In addition, past studies of sales growth and overhead expenses (see TEBS Spring 1997 and Winter 1996) have also focused on the same general group of 10 or 15 stronger-performing companies. Finally, surveys of executive compensation have shown that many of these same companies possess executive teams that are providing their shareholders with greater growth and stronger profitability at lower relative costs.
The TEBS model for calculation of top performers is based on what we believe must ultimately be the most important attributes of a successful company - the ability to generate profits as (1) a function of selling a product or service, and (2) a function of the shareholder capital employed. Specifically, the ranking is based on two key metrics - return on sales (net after-tax income as a percentage of net revenues) and return on equity (net after-tax income as a percentage of shareholder equity) over the last four quarters. Put simply, these companies have figured out how to sell a product or service that people want, and make money doing it, even in the rapidly changing and highly competitive market conditions that have characterized the past several years.
Table 1 lists those companies that rank in the top 25 percent of all the companies in the TEBS portfolio, in terms of one or both of these key measures of performance, for the time period comprising the most recent trailing four quarters.
As in any statistical study, it is important to keep a few cautions in mind. For example, ratio measurements can be high because the numerator is large or because the denominator is small. More specifically, the calculated return on equity (ROE) can be a deceptive number; it is a function both of the amount of after-tax profit and the percentage of equity in the overall capital structure. For any given level of income, ROE increases as the percentage of equity decreases; it can obviously go to infinity if the company is totally debt financed. In other words, a high ROE can mean the company is highly leveraged but does not necessarily mean that the company is highly profitable.
Our second measure - net return on sales (ROS) - is perhaps less subject to misinterpretation; in most instances one does see increasing percentage profitability due to decreasing revenue levels. It seems clear that a consistently high return on sales is a strong endorsement that the company is performing all aspects of its business well. Hence, in order to create our final ranking of top performers, we utilized a weighted average that equally balanced both ROS and ROE. In addition, to stress the importance of a balance between both perspectives, and to remove those companies which really only "make the grade" in one attribute, we include only those firms that appear in the top quartile for both measures.
Table 2 shows the top 10 performers for 1998. These companies represent the "cream of the crop" in the environmental services industry. (The weighted average figures for these top firms have been restated and normalized on a scale of 90 to 100.) A careful review of these players yields insights regarding both the top companies as well as the most attractive sectors, in terms of current potential for growth and profitability. As can be seen by comparing this list with our results from previous years, many of the same companies are still ranked head and shoulders above the rest of the industry - in fact, the list is developing a certain consistency from year to year. Likewise, again as in past years, certain sectors seem to be more consistently represented here than others.
Taking top honors is Hach Co., a Loveland, Colo.-based manufacturer of water testing and monitoring equipment, which has recently been acquired by Danaher Corp. Hach has appeared in the TEBS top performers list almost every year, and has garnered a well-deserved reputation as one of the best-managed and most successful companies in the environmental industry. The company has a relatively low investor visibility because of its low percentage public stock float, and because the stock is closely controlled by the founding family. Nonetheless, the firm has set the standard for consistency in terms of sales and income growth.
Just behind Hach this year is another water sector company, albeit a much different and much better known one - Nalco Chemical. Nalco is one of the larger companies profiled in these pages, but it is an equally successful and sustainable business - the company is successfully evolving from a specialty water chemicals producer into a broader-based and more integrated water treatment services firm. Other water-oriented companies joining the group this year include Aquarion - a Connecticut primary water utility; Betzdearborn - another old and large chemicals manufacturer, which has been acquired by Hercules; and Cuno - a relatively newer public company in the water treatment technology arena, recently spun off from its long-time parent Commercial Intertech.
The other sector that has traditionally made a strong showing in the annual performance rankings is instrumentation. This year both Danaher and Thermo Instrument are top-ranked companies. Rounding out the list are two of the more aggressive, and now largest solid waste companies - USA Waste, and Allied and Newpark Resources - one of the most remarkable diversification and success stories in the environmental industry today. Newpark provides specialty environmental and site management services to the petroleum exploration and production industry, primarily in the Gulf Coast region, and has built a very profitable and sustainable business in this area.
What traits and characteristics do these companies share? What do they have in common, and what lessons can other companies learn from these leading firms?
First, these companies generally come from just a few sectors - primarily water and instrumentation. This is simply a reflection of those areas of the industry that are currently the most viable and robust. However, other companies like Newpark are also represented, emphasizing the fact that the best-managed companies find a way to perform well, despite weak industry conditions. All of these companies are well-diversified in terms of clients and end markets, and few rely solely for their existence upon the heavily regulated hazardous or industrial waste management markets for their revenues. A look at the rest of the companies here also points to the same conclusion - greater client and end market diversity are strongly correlated with greater profitability in this industry.
It is important to recognize that this model represents a "snapshot" in time; although we believe that this ranking is a good indicator as to future leaders, other factors may enter into the short-term strategic plans of various companies. Some companies may be heavily investing now to position for the future, possibly at the expense of current profitability. For example, companies heavily involved in implementing costly acquisition strategies, such as U.S. Filter, may not appear in our rankings here in terms of current return on investment or profitability. Presumably, however, these companies are betting that they will be there in the future. As we have shown in the past, bigger is not necessarily better in this industry, though most sectors do exhibit significant economies of scale. Only time will tell if these approaches are ultimately more successful.
Environmental consulting and engineering firms: How well are they performing?
Most readers will note that in the accompanying story on the overall industry, there is little mention made of environmental engineering and consulting firms. Where are the companies that most clients are used to dealing with in a day-to-day sense - the Dames and Moores, the Montgomery Watsons, the CH2M Hills, the Roy F. Westons? Unfortunately, few of these engineering and consulting firms show up in surveys such as this, because most of them rank fairly low in terms of general financial performance relative to the overall industry - at least over the last few years.
The fundamental problem in the consulting sector over the past several years has been a distinct over-capacity of services relative to demand. Demand for environmental consulting services skyrocketed during the 1980s, as a plethora of new and demanding regulations took hold in American industry. The environmental consulting business was - and still is - a fairly easy one to get into; there are few substantial barriers to entry or high capital requirements to overcome. Hence, many new firms sprang up to meet this burgeoning demand; in addition, many traditional engineering and construction firms turned toward the emerging environmental field. For quite a while - through most of the 1980s and into the early 1990s - everything went very well. Both new and old engineering firms thrived in the environmental consulting business.
However, while the demand for environmental consulting services has continued to grow, over the past few years it has only done so at much lower rates, and in the face of rapidly developing excess capacity. By the mid 1990s, the growing imbalance between supply and demand was beginning to cause serious price declines, and the environmental consulting field entered a period of consolidation, a "shaking-out" of capacity and a re-structuring that - as demonstrated by the recent spate of mergers in the industry - is probably still far from over. This restructuring and removal of capacity through consolidation is not unlike what is happening in the hazardous waste management arena, or what the laboratory services sector of the industry endured several years ago.
What these industry fundamentals have translated into, at least for most companies, has been severe price competition, low or non-existent profits, and revenue shrinkage - in general, very trying economic times. Hence, lately very few environmental consultants have ranked among the top financial performers in the overall environmental services industry. The majority of publicly traded consulting firms have shown financial losses and shrinking revenues during the past four of five years.
That being said (and as always seems to be the case in any industry) there are a few companies in the environmental consulting sector that have still consistently ranked head and shoulders above the rest. The two key public companies have been Tetra Tech and Dames and Moore. Both of these firms have been able to consistently generate after-tax income in the range of 5 to 10 percent. With annual revenues of roughly $1 billion, Dames and Moore has just announced the sale of its company to URS Corp. Tetra Tech in particular has set the standard for consistent growth and profitability among consultants, turning in year after year of improving performance figures.
Finally, it is important to remember that many of the largest and most respected firms in the environmental consulting field are, in fact, privately held; detailed financial information is therefore not available, and these firms are not included in surveys of publicly traded companies. Many of the largest and most respected engineering consultants fall into this category, such as CH2M Hill, Montgomery Watson, and Brown and Caldwell. Although these firms don't release financial figures, many are reputed to be quite successful financially.
Please see our August print edition for detailed information on company rankings.
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This article originally appeared in the 08/01/1999 issue of Environmental Protection.