The waste management industry has evolved into a sophisticated recycling and recovery process but still has its foundations in basic collection services. Cleanaway’s challenge is to profitably fund the future assets and technology while sustaining the base contracts and services.
Blueprint 2030
In November 2022 CWY revised its strategy to improve profitability, make further investments and drive market share. Logically, for a waste management business, much of the new strategy is centred on sustainability in its many forms. Across its infrastructure, the strategy considers elements such as landfill optimisation and energy from waste (EfW). Operationally, there are factors such as fleet optimisation, data and analytics, hydrocarbons optimisation and the core operating model itself.
Extending the recycling and landfill diversion infrastructure is a key focus. Acquiring the Sydney Resource Network in December 2021 was a major step in that process. CWY’s objective is to participate in all aspects of waste management including extracting energy from waste (EfW) before disposal.
Acquiring suitable land for the purpose of waste treatment is obviously a difficult task, along with the necessary approvals and licences to operate. This aspect is a top risk factor for the business.
Expansion of the construction and demolition (C&D) is a priority which goes hand-in-hand with the resource recovery business. The role of transfer stations and landfills are also critical parts of the chain.
The financial goal of Blueprint 2030 is to drive ‘solid’ EBIT growth based on margin recovery.
Cornerstone Questions
What is the opportunity and risk of Energy from Waste (EfW)?
CWY has been working towards developing an ‘energy from waste’ strategy for some time. Intuitively this makes sense on two fronts (1) it reduces waste to landfill and (2) it creates value through generating a useful product from the waste. But the cost of establishing EfW projects looks to be higher than CWY had envisaged. At its most recent update, CWY now expects its EfW capex to be 15-20% higher than planned and it is to be funded on-balance sheet rather than de-risked by selling down equity in these projects in Victoria (Wollert) and Queensland (Bromelton). The higher capex will feed into higher depreciation charges in FY24f to the tune of about $20m.
The shift in approach to funding the EfW strategy is cause for concern as it makes these projects potentially marginal.
Average leverage could exceed management’s targets in FY25f (<2.5x) even under an improving earnings outlook. This does not render the projects unworkable but does add a higher risk element.
So far, the only return metric the company is discussing is a post-tax equity rate of return in the high single digit to low double-digit range.
Can CWY restore margins to ~12%?
CWY has a large labour force (>7,500) across its branch network including drivers and administration people. The manual paper-based systems have been a drag on profitability through inefficiency and error rates. The problems are twofold (1) CWY needs to retain and train a more dependable workforce and (2) it needs to digitalise its systems to improve efficiency. Both factors are crucial elements in lifting CWY’s EBIT margins above recent depressed levels.
CWY has provided a business-as-usual EBIT margin target of 12% and we expect the company will provide further detail at its FY23 profit announcement in August. The target is attainable if input cost pressures abate and CWY can lift its operational performance.
FY23 guidance is for EBITDA of $670m and EBIT $300m. Margin recovery is expected to drive EBIT growth to create a ‘growing EBIT (CAGR) range’.
Will there be any industry consolidation?
CWY itself has been a consolidator with its most significant acquisition being the 2017 purchase of Tox Free Solutions for $671m. CWY paid a multiple of 10x FY17 EBITDA (7.1x post synergies) for TOX.
More recently, CWY paid 7.9x EBITDA for GRL in 2022.
Other major waste management companies include JJ Richards & Sons, Veolia (acquired Suez in 2022), Remondis, and Bingo. With large, fixed costs, scale is important, so further industry consolidation is likely, subject to ACCC intervention. The regulator would be a potential barrier for large acquisitions as evidenced by its influence in the Veolia/Suez transaction. In a fragmented market, there will still be opportunities for smaller, incremental acquisitions subject to the ACCC’s approval on a case by case basis.
A key factor to consider is the scarcity of landfill assets. CWY acquired two landfills and five transfer stations from Suez in 2021, partly because of the ACCC’s response to Veolia’s acquisition of Suez. It could be argued that the value of landfills is increasing but these are not ordinary properties. Landfills are heavily regulated, emit large amounts of methane and must eventually be rehabilitated. The book value of CWY’s landfill assets as at 30 June 2022 was $364m in a total PP&E asset of $1,434m.
CWY’s New Chum landfill in Queensland recently lost an appeal in the Planning and Environment Court to extend its airspace (upon which landfill depreciation is based). The site is facing rectification costs of approximately $40m following its temporary closure due to flooding. The site was closed in March 2022 and is yet to be re-opened under more stringent requirements. The total assets at New Chum subject to the appeal were reported as $31m as at 30 June 2022. CWY has disclosed a potential $70m impairment relating to the unsuccessful height rise application.
Investment View
Waste management is a structural growth industry but presents elevated regulatory and operational risks. CWY is Australia’s largest industry participant with over 7,500 employees, a fleet of more than 5,000 specialist vehicles across 250 branches across Australia. The shift to recycling, re-use and avoidance of waste presents the opportunities for CWY to add shareholder value. The risks are the regulatory and operational hazards that confront the industry on a daily basis.
Mark Schubert was appointed CEO/MD of CWY in August 2021 after a background at major energy companies (Origin Energy, Shell). He has subsequently rearranged the management team to suit the company’s new strategy. Mark Chellew has just announced his retirement as Chairman of CWY and will be succeeded by his Deputy, Phillipe Etienne. The Board has also seen several new appointments in the last two years. The management transition occurred in the midst of COVID-19 so it is too early to judge their performance, especially against the Blueprint 2030 strategy.
In an industry that should be growing at a GDP-plus rate, CWY’s sluggish revenue growth is perplexing. It may reflect the competitive nature of contract pricing where there are many sub-scale operators.
CWY’s leading industry position and currently low but recovering earnings suggest that timing is ideal to acquire the stock. We initiate our coverage with a Buy recommendation.
Risks to Investment View
Regulatory requirements in the waste management industry are many, including waste levies, carbon tax, environmental regulation and planning regulations. Changes in these factors could affect CWY’s ability to operate. This is an assets-heavy industry so operational risks are abundant including the risk of site loss, environmental factors, industrial disputes and technology risks. Competitive threats are possible. The company has a high exposure to health and safety risks. Financial and cybersecurity risks are also apparent.
Recommendation
We commence our coverage of CWY with a Buy recommendation.
Figure 1: EV/EBITDA
At 10.8x FY23f EV/EBITDA, CWY is trading near its long-term average. The industry does attract reasonably high valuation multiples given the increasing technology requirements, increasing regulatory burden and asset scale needed.
There is also arguably a ‘green’ element to the valuation as the community demands increasingly high levels of circularity in the economy – recycling and waste reduction.
Figure 2: PE RATIO
Figure 3: PEER GROUP
A selection of peer stocks shows the relatively high multiple (EV/EBITDA) ascribed to the international waste management specialists, suggesting CWY might be undervalued. CWY’s 3-year EPS compound growth rate measures the expected impact from higher margins. CWY’s relatively low return on equity measure is due to the large amount of goodwill on the balance sheet ($2.4bn).
