The environmental services sector, which rebounded strongly from the initial COVID-19-related slowdown, is poised for sustained growth going forward, powered by long-term tailwinds and the enactment of the Infrastructure Investment and Jobs Act. Meanwhile, against this backdrop, a labor shortage combined with supply chain bottlenecks will present both challenges and opportunities.
This outlook comes from a recent study conducted by L.E.K. Consulting to assess the environmental services market outlook. Based on a number of in-depth conversations with environmental services executives, we identified eight core trends that current and potential investors in the space should keep top of mind for the rest of 2022 and beyond:
- The environmental services sector has been relatively sheltered from the impact of COVID-19
- Long-term tailwinds, including heightened environmental consciousness and the push for environmental, social and governance (ESG) policies, are expected to continue to support sustained growth
- The infrastructure bill will add to the sector’s existing funding tailwinds over the next decade
- Labor shortages will likely persist against the backdrop of growth
- Demand, combined with labor-driven supply constraints, could lead to pricing and margin growth
- Strategic differentiators will include digitalization, automation and offshoring, as well as effective labor recruitment and retention
- Industry consolidation and M&A activity are expected to continue in many environmental services segments
- Identifying synergetic acquisition platforms remains a winning value-creation strategy
Taken together, these trends make environmental services an interesting and dynamic space in which to invest.
The environmental services sector has been relatively sheltered from the impact of COVID-19
Compared to many other sectors, environmental services have been broadly shielded from the impact of COVID-19. While Q2 2020 saw some delayed projects, these delays did not last very long given the “essential business” status of the industry and the desire from public and private sector customers to keep projects going. Some segments even saw business activity accelerate due to greater demand for indoor hygiene and related facility services. Overall, the negative effects of COVID-19 have proven to be quite temporary, while the positive impacts of the renewed focus on health and hygiene are expected to stay.
Long-term tailwinds are expected to continue to support sustained growth
Certain subsectors, such as restoration and specialty waste services, have gained further speed from long-term growth tailwinds during the COVID-19 pandemic, among them a broader push for ESG policies. And with post-COVID-19 normalization continuing to set in, the long-term outlook across all subsectors of environmental services is now positive.
The infrastructure bill will add to the sector’s existing funding tailwinds over the next decade
In November 2021, Congress passed the Infrastructure Investment and Jobs Act, which will add to the tailwinds already powering the sector by driving additional demand for a range of environmental services from abatement to remediation. As one restoration services senior executive put it, “If you combine the long-term tailwinds of the environmental services space and the expected impact of the infrastructure plan, you really get to a very optimistic picture.” Indeed, environmental consulting and remediation will be especially impacted by the $1.2 trillion bill (see Figure 1), which will provide the sector with a total of $1 billion to clean up more than four dozen toxic waste sites.
Labor shortages will likely persist against the backdrop of growth
Employees with low-level skills or with skills not specific to the sector, such as truck drivers, laborers and minimum-wage workers, are in short supply. Meanwhile, sourcing and retaining engineers as well as environmental consultants, who can easily transfer their skills to other industries, is another hurdle. Environmental services-specific labor, on the other hand, remains broadly available as those workers have less transferable skill sets but earn relatively high compensation, which makes them loyal to the space (see Figure 2).
Demand, combined with labor-driven supply constraints, could lead to pricing and margin growth
As demand continues to grow — and with it, the imbalance relative to supply — environmental services companies will continue to be subject to significant inflationary pressures. But they will also find opportunities to expand margins. “The demand is relentless,” noted one senior environmental consulting executive, and companies that can tackle that demand “have all the bargaining power.”
Strategic differentiators will include recruiting and retention, as well as digitalization, automation and offshoring
Going forward, employee satisfaction will play a much larger role in defining the sector’s winners and losers. Indeed, recruiting and retention efforts have become a much higher priority than in years past and are being used to differentiate from the competition, with many environmental services companies placing a particular emphasis on company culture. Offshoring of data review and interpretation is another strategy being used to mitigate the labor shortages, as is the use of digitalization and automation of necessary processes, such as monitoring leak data analytics and upgrading machinery. But none of these approaches are likely to significantly expand the space’s much-needed supply (see Figure 3).
Industry consolidation is expected to continue in many environmental services segments
While the environmental services space remains fragmented, the markedly positive outlook for the industry is creating an incentive for further consolidation among particular subsectors of the space, especially since it offers multiple opportunities for arbitrage (see Figure 4). In fact, with an eye to the profit that industry executives are seeing on the horizon, some companies are already making moves to snap up acquisition targets before their full profit potential has materialized. Consolidation opportunities include smaller firms that still belong to founders who are retiring without necessarily having a viable succession plan.
Identifying synergetic acquisition platforms remains a winning value creation strategy
Valuations for at-scale environmental services players have expanded significantly — “eye-watering” was the term used by one restoration services investor — as there is a lot of capital chasing a limited set of “already consolidated” assets in the space. All of this leads to growth valuations being applied to companies that, despite being robust and growing nicely, are not really growth assets. It’s why, amid the push for consolidation, finding synergetic acquisition platforms will be so important going forward.
Environmental services were already benefiting from long-term tailwinds when COVID-19 shut down the globe in the spring of 2020. And while certain segments of the space were negatively impacted by the pandemic, generally speaking, it weathered the effects better than most. Now, with the worst of COVID-19 ostensibly behind us and the enactment of an unprecedented infrastructure spending bill, current and potential environmental services investors that pay close attention to these overarching trends could find themselves with a once-in-a-lifetime opportunity.
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