Ceco Environmental (CECE) Stands to Lose “Bigly” from Trump’s Environmental Policies

Price Target $7.20

  
January 31, 2017 (updated)

Note 1:  On March 23rd of last year, CECO Environmental Corp (NASDAQ:CECE) stated on page 8 of its 2015 Annual Report under the​“Government Regulations” section:  “We believe that changes in environmental laws and regulations create opportunity given the nature of our business.”  That’s probably true if one is to assume those changes referred to more stringent environmental regulations.
Note 2:  Last Tuesday, President Donald Trump issued four presidential memoranda and one executive order, all of which environmentalists have criticized as being harmful to the environment.  We shall discuss these pronouncements in a bit more detail furter below.

Note 3:  Last Tuesday, the same day Mr. Trump signed the four presidential memoranda and one executive order that had environmentalist in an uproar, the Chief Executive Officer, President, and Board Member of CECO Environmental Corp. (NASDAQ:CECE) Mr. Jeffrey Lang announced his resignation in all three capacities effective tomorrow.  Mr. Trump’s stance on the environment, while seen as beneficial to some businesses, will have a dramatic and negative impact on CECO Environmental.  Possibly, Mr. Lang saw this coming and threw in the towel before it got too late?  The Board appointed current Board member Dennis Sadlowski to serve as interim CEO while the company searches for a replacement. 

In this report, we will take a look at President Trump’s views on the environment versus the economy and unemployment; we will also take a brief look at the views expressed by his inner circle; and finally, we will discuss CECO’s performance to date and what we can expect going further.


Who is CECO Environmental?   CECO Environmental is a leading global technology company that provides clean, safe, and efficient fluid handling and filtration, energy, and environmental air pollution control.  Through its various brands, CECO provides some of the products and services that help companies meet stringent emissions control regulations, increasing plant needs, and achieve exacting production standards.  The company focuses on helping industries achieve clean and safe environmental air pollution control, energy production, and fluid handling and filtration technology.  According to the company’s most recent annual report, it operates through three reportable segments:  the Environmental Segment, the Energy Segment, and the Fluid Handling & Filtration Segment.

The Environmental Segment provides the design and manufacture of product recovery and air pollution control technologies that enable its customers to meet compliance targets for toxic emissions, fumes, volatile organic compounds, process and industrial odors. These products and solutions include high efficiency cyclone systems, scrubbers, regenerative thermal and catalytic oxidizers, dust collectors and baghouses, standard and engineered industrial ducting, fabric filters and cartridge collectors, ventilation and exhaust systems for emissions and contaminants, and process cooling systems for steel in rolling mills.

The Energy Segment provides customized solutions for the power and petrochemical industry.  This includes gas turbine exhaust systems, dampers and diverters, gas and liquid separation and filtration equipment, selective catalytic reduction (“SCR”) and selective non-catalytic reduction (“SNCR”) systems, acoustical components and silencers, secondary separators (nuclear plant reactor vessels) and expansion joints, the design and manufacture of technologies for flue gas and diverter dampers, non-metallic expansion joints, natural gas turbine exhaust systems, and silencer and precipitator applications, primarily for coal-fired and natural gas power plants, refining, oil production and petrochemical processing, as well as a variety of other industries.

The Fluid Handling & Filtration Segment provides the design and manufacture of pump filtration and fume exhaust solutions. This includes centrifugal pumps for corrosive, abrasive and high temperature liquids, filter products for air and liquid filtration, precious metal recovery systems, carbonate precipitators, and technologically advanced air movement and exhaust systems. These products are applicable to a wide variety of industries, particularly the aquarium/aquaculture, plating and metal finishing, food and beverage, chemical/petrochemical, wastewater treatment, desalination and pharmaceutical markets.

Clearly, this is a company that stands to benefit “bigly” or “big league” as the case may be from more stringent environmental regulations.  Conversely, the company stands to lose significantly from less stringent environmental regulations.  The excerpt below from page 10 of the company’s most recent annual report says it best:
  
It is very clear that our new president has little tolerance for “red tape” as he’s stated on multiple occasions.  In fact, just yesterday he signed an executive order proclaiming that, “The total incremental cost of all new regulations, including repealed regulations, to be finalized this year shall be no greater than zero, unless otherwise required by law or consistent with advice provided in writing by the Director of the Office of Management and Budget.”


Trump’s Views on the Environment:   Mr. Trump has often said that environmental regulations are “out of control.”  Speaking to automobile industry leaders last week, he complained that, “Our friends that wanna build in the United States, they go many, many years and then they can’t get the environmental permit over something that nobody ever heard of before,” he said. “And it’s absolutely crazy. I am, to a large extent, an environmentalist. I believe in it. But it’s out of control.”  He promised to restore manufacturing jobs, slash taxes, and curb “unnecessary” regulations.  “Were going to either give you your permits or we’re not gonna give you your permits,” he said. “But you’re gonna know very quickly. And generally speaking, we’re gonna be giving you your permits. So we’re gonna be very friendly.”

The five executive actions taken last Tuesday take direct aim at President Barack Obama’s environmental policies by advancing two very controversial pipelines and streamlining regulations on domestic manufacturing and infrastructure projects.  President Obama made climate change and protection of our national resources high priorities.  Not so with this president.

First is the Presidential Memorandum Regarding Construction of the Dakota Access Pipeline, which would extend from the Dakotas to Illinois.  According to the Memo, this action “represents a substantial, multi-billion-dollar private investment in our Nation's energy infrastructure. This approximately 1,100-mile pipeline is designed to carry approximately 500,000 barrels per day of crude oil from the Bakken and Three Forks oil production areas in North Dakota to oil markets in the United States. At this time, the DAPL is more than 90 percent complete across its entire route. Only a limited portion remains to be constructed.”  The Standing Rock Sioux Tribe, whose reservation is within a mile of the pipeline, has bigly opposed the project.  The tribe has been worried about water contamination, and the U.S. Army Corps of Engineers recently had previously agreed to look into less intrusive alternatives.

Next is the Presidential Memorandum Regarding Construction of the Keystone XL Pipeline, which would carry crude from Alberta, Canada to the Gulf of Mexico.  President Obama put a stop to it because, in his view, the environmental cost was too much for a relatively modest supply of oil, and would have been at odds with this nation’s commitment to join a global pact to reduce greenhouse gases.  Trump has invited TransCanada to resubmit its application for the pipeline.  Another Presidential Memo the same day specifies that all new and repaired pipelines be built with American steel.

Finally, there’s the “Executive Order Expediting Environmental Reviews and Approvals for High Priority Infrastructure Projects” and the “Presidential Memorandum Streamlining Permitting and Reducing Regulatory Burdens for Domestic Manufacturing.”  The infrastructure order calls for a streamlined and expedited environmental review of all high priority infrastructure projects.  The manufacturing memo calls for reduced regulatory burdens affecting domestic manufacturing.  This memo calls for the Secretary of Commerce to “coordinate” with the EPA and other agencies to streamline permitting and reduce regulatory burdens for domestic manufacturers. 

If those actions did not make it clear where Mr. Trump stands regarding environmental regulations, then his other set of actions will.  Not only has he frozen the EPA’s budget and barred it from awarding any new contracts or grants, he has ordered a total media blackout at the Agency.  EPA employees are not allowed to post to social media, respond to journalists’ questions, interact with members of Congress, or send out press releases.  This is all part of a move to kill or at least delay some thirty or more environmental rules finalized in the closing months of President Obama’s term. 


Trump’s Team on the Environment:   We know how Mr. Trump feels about the environment, but what are the views of his team members?

Trump’s EPA transition director, Myron Ebell, a climate-change skeptic, just yesterday suggested cutting the EPA workforce by 66% over the next four years and slicing the Agency’s budget by half.  According to Ebell, “The global warming fad is waning.”  Mr. Ebell was among the first of Trump’s transition team agency leaders to be announced, and he had even been discussed as a possible EPA director.

Trump's pick for EPA director, Oklahoma Attorney General Scott Pruitt’s actions in court suggests the same views.  Mr. Pruitt, who has sued the EPA a total of 14 times as Oklahoma’s attorney general, does not believe human activity is the primary cause of climate change.  However, NASA and the National Oceanic and Atmospheric Administration announced recently that 2016 was the hottest year in recorded history, and said human activity is to blame.  Environmental leaders say that Pruitt, if confirmed by the full Senate, would be the most hostile EPA chief in the history of the agency, which was created in 1970 by former President Richard Nixon to protect human health and the environment.  Since being elected Oklahoma attorney general in 2010, Pruitt sued the EPA over its Clean Power Plan, which aimed to reduce emissions from coal-fired plants that contribute to climate change; he also sued the EPA over regulations to reduce methane emissions from the oil and gas industry; he questioned whether toxic mercury pollution is hazardous to public health; he shut down his office’s Environmental Protection Unit; and he launched a  new “Federalism Unit” devoted to filing legal challenges against the EPA—at least 14 of them. 

According to Time, “While Pruitt was busy trying to kill national mercury rules, the number of Oklahoma lakes listed for mercury contamination was climbing.  This year, the state lists 40 lakes with fish consumption advisories due to mercury levels—up from 19 listed in 2010.  Eight lakes were added just this year…Pruitt also attacks limits on ground-level ozone—better known as smog—despite the fact that ozone problems are acute and worsening in Oklahoma. The latest American Lung Association report gave all Oklahoma counties surveyed an “F” for ozone problems and found that the number of high ozone days had increased in most counties as compared to 2010-'12.”

Clearly these developments do not bode well for a company whose primary source of revenue comes from helping companies preserve and protect the environment.  Indeed, on pages 3-4 of the company’s most recent annual report, the company states that demand for its products and services will continue to be driven by specific factors (which we see as being in jeopardy for the next 4-8 years).  See excerpt below.
  
  
These factors include a more stringent regulatory environment (in which clearly this new administration does not believe) and a shift toward natural gas and renewables (in which this new administration has shown a marked preference for oil and coal).  The next CEO of Ceco Environmental will take the helm facing a multitude of headwinds and uncertainty for sure.

CECO’s Performance to Date:   Even before the headwinds facing Ceco, which we’ve highlighted, the company was facing a multitude of problems.  First and foremost, top line growth had been decelerating for the past 3 years.  For the first three quarters of 2016, revenue growth came in around 19% over the same period for the prior year.  Contrast that to the first 3 quarters of the previous 2 years.  Top line growth increased by 46% and 42% for the first 3 quarters of 2014 and 2015 respectively.  The company's historical competitiveness in operations is slipping away as a most inconvenient time.

Debt has been steadily increasing.  Total liabilities were $32M at the end of 2012, $178M at the end of 2013, $234M at the end of 2014, and $354 at the end of 2015.  Debt, in and of itself, is not a problem per se.  However, when the company uses debt to finance growth, and growth starts to slow we begin to wonder how wise a decision its acquisition decisions were over the last few years.

Speaking of acquisitions, for the 2013 fiscal year, top management was able to state in its annual report, “Based on the assessment of the processes for the Company as described above, management of the Company believes that as of December 31, 2013, internal control over financial reporting was effective.”  The same statement was made in all previous annual reports which we reviewed, and were each accompanied with an unqualified opinion (the highest type of opinion) from its external auditors.  Beginning in 2014 with the purchase of Chinese subsidiary Zhongli Industrial Technology Company and continuing onward, the company’s management noted that “significant deficiencies in the financial reporting process related to the adequacy of accounting personnel and oversight, accounting for income taxes, and segregation of duties, among others, when taken in the aggregate, amount to a material weakness in our internal control over financial reporting.”  Yet another headache for a new CEO to deal with.

Looking Forward:   Ceco is overvalued by any metric. Within the last three months, insiders have sold more than they’ve bought by a near 9 to 1 ratio.  The company  is trading at an elevated PE, and its pace of growth had slowed.  If we’re expecting EPS of $0.20 for the final quarter of 2016, the company is trading at a current PE ratio of 23.  Given the headwinds and uncertainties facing the company, we think a forward PE of 12 is very appropriate.   With our forecast of 2017 earnings per share of $0.60, we impute a fair price of $7.20.