Montrose Environmental: Attractive Business Model; Upside Potential (NYSE:MEG)

summarize

I recommend buying Montrose Environmental (NYSE: MEG). The environmental industry is challenging due to its complex regulations and fragmented market.Therefore, customers are looking for environmental solution providers who can deal with the problem comprehensively life cycle and across different jurisdictions. MEG aims to target an oversaturated market with many competitors, many of which specialize in specific niches or regulations. Due to its global reach and diverse product range, MEG’s strength lies in its ability to attract and retain clients and develop relationships. When competing for large accounts requiring nationwide suppliers, MEG distinguished itself by its ability to provide a unified, geographically dispersed service and a single point of contact for all of its customers’ needs.

Company Profile

Environmental testing and air quality testing are among the services Provided by MEG. The company’s customers include waste management centers, power plants, water purification plants, municipalities and multinational corporations around the world.

The environmental protection industry is a tough nut to crack

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

As stated in MEG S-1, its target market is filled with thousands of competing businesses. Many larger companies provide limited environmental services as an afterthought to their primary business. However, most of the businesses serving the industry are small and specialize in serving a narrow range of markets or complying with a narrow range of regulations. Given the technical knowledge, certifications, and licenses required to serve a wide range of customers and industries across geographies and service lines, I see structural barriers to expansion for smaller companies. Due to these factors, entering the MEG industry is very difficult.

I believe customers will place greater value on large environmental solutions providers as they are looking for efficient, individualized ways to reduce their environmental impact. Especially for businesses and organizations operating in multiple jurisdictions subject to complex regulatory frameworks, suppliers who can address the full lifecycle of environmental concerns and requirements will maintain a competitive advantage (i.e. MEG).

Apart from this, demand and demand for environmental services is growing due to rising public awareness and stakeholder demand for environmental sustainability. Due to the widespread adoption of CSR and ESG programs, corporate environmental impact has become an integral consideration. Instead of focusing solely on ensuring compliance, as in the past, these efforts focus on proactively managing emerging threats.

Demand for environmental services is also driven by a number of other factors, including continued growth in industrial activity and infrastructure investment, as well as related regulations. Further stimulating demand are disturbances in the natural environment caused by factors such as climate change and infrastructure degradation.

MEG, a one-stop shop with significant global reach

With the addition of new products, MEG is now better able to meet all of its customers’ environmental service needs. 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 service providers, may not have in-house testing capabilities and instead contract with external providers.

In addition, MEG’s operations span the globe. I think MEG’s ability to provide a unified, geographically dispersed service offering is highly valued by its customers. MEG’s strategic mergers and hiring have given the company the scale needed to compete globally and complete projects. The company’s international reach helps MEG win new customers and meet the needs of its existing customers. In my opinion, MEG’s reach and comprehensive product portfolio make it an important player in attracting new customers and retaining existing ones as more and more customers look for an environmental solutions provider that can handle their problems Well-positioned to develop and develop existing relationships with clients in multiple jurisdictions.

All in all, I think being able to provide a single point of contact for all a client’s needs is a major selling point when competing for larger accounts that require a national scale provider. From a large customer perspective, dealing with a single supplier is simpler than dealing with a collection of point solutions that may or may not be compatible with each other. This distinction becomes even more pronounced when we talk about multi-million dollar projects that take years to complete.

Long-term and diversified customer base reduces business risk

MEG has worked with many Fortune 1000 companies and government agencies over the years, just some of the more than 5,300 clients they currently serve. In addition to its large client base, MEG’s revenue is spread across numerous projects and geographies. Additionally, MEG completes anywhere from one to dozens of projects per year for these clients. What’s more, MEG’s financial success is not dependent on spending by a single customer. MEG also caters to a large number of industries and organisations. As such, MEG’s business is not heavily dependent on any one industry, which I think makes it more resilient to downturns in that industry.

attractive business model

I think MEG’s relative insensitivity to political changes in its profits is one of the company’s biggest selling points. One reason for this is that it is not tied to any particular set of regulations to function. In addition, MEG operates in many different geographies and assists clients in meeting various regulatory requirements. As such, MEG is generally immune to major changes in legislation. While the federal government sets some basic requirements, many states, provinces and municipalities have even stricter laws. As a corollary, state, provincial and municipal governments often outline the procedures to be followed in order to meet or enforce environmental standards. When different government departments cooperate, policy changes are less likely and have less impact.

In my view, MEG’s ability to weather the economic storm is due to the breadth and depth of its service offerings and the diversity of industries it serves. It’s important to remember that regardless of the economic cycle, different industries may experience peaks in customer activity at different times. In addition, many of MEG’s service offerings are often non-discretionary, and projects often generate significant value customers, further encouraging continued use of MEG’s services.

Growth opportunities from M&A

MEG’s phenomenal growth is due in large part to its policy of aggressive expansion through acquisition; the company has acquired more than 50 companies since its inception. To expand its service offerings and geographic presence, MEG typically looks for acquisition targets with strong management teams that can introduce innovative new technologies and processes. As MEG competes in various niche markets, I expect the company to maintain its acquisition nature.

3Q22 results on schedule

MEG announced 3Q22 financial results in line with expectations. Importantly, MEG’s services in treating PFAS-contaminated water, producing renewable energy and measuring greenhouse gases remain in high demand. Also, MEG has not changed its FY22 revenue guidance, which remains at US$535-555 million and adjusted EBITDA margin of US$68-73 million. I’m also reassured by the company’s comments, which suggest the company has been successful in raising prices and expects the sequential improvement in quarterly margins to continue into 4Q’22.

Valuation

I believe MEG has a 21% upside potential. I expect MEG to continue growing revenue based on historical underlying revenue growth rates (high single digits) driven by continued secular trends. Furthermore, MEG should continue to expand margins sequentially each year as it further optimizes its cost base and achieves management’s long-term target (20%).

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

risk

M&A risk

MEG’s growth is largely due to acquisitions, and I believe this trend will continue. If the company does not close as many deals, MEG’s future growth rate may be lower than its historical trend. Revenue and cost synergies could also be lower than expected if MEG is unable to successfully integrate the acquired companies. A high rate of mergers and acquisitions can also make it difficult for companies to build a coherent culture.

Investors Difficult to Value MEG

To be successful in the markets it serves, Montrose must compete with larger companies offering similar services, while offering more comprehensive solutions than its smaller regional competitors. In the absence of direct public competitors, investors may find it more difficult to assess MEG’s performance relative to the market.

in conclusion

Complex regulations and a fragmented market make the environmental industry difficult to enter. As a result, businesses are looking for environmental service providers who can address issues across a wide range of industries and geographies. Because of its global presence and extensive service catalog, MEG is better positioned to win new business, delight existing clients and cultivate existing partnerships.