We recently researched Cleanaway Waste Management (ASX:CWY) in The Dynamic Investor on 15 March 2022 following the release of results for the six months to 31 December 2021 (1H22). The shares had come off previous highs, as investors sold off high-P/E stocks. There were also market concerns about some risks associated with the long-term Waste-to Energy strategy. With the shares having since recovered back up towards the recent highs, is there another re-entry opportunity?
About Cleanaway Waste Management
Cleanaway Waste Management is an Australian-focused industrial, waste and environmental services company. It operates in three segments: Solid Waste Services (‘SWS’), Liquid Waste & Health Services, and Industrial and Waste Services. Solid Waste Services involves the collection, recovery, and disposal of solid waste. Liquid Waste & Health Services involves collection, treatment, processing, refining, recycling and destruction of liquids, hydrocarbons, chemical waste, specialised packaged and hazardous waste and e-waste, and the safe treatment and disposal of health-related waste. Industrial and Waste Services provides a wide variety of services to Infrastructure and Resources markets.
CWY’s revenue base is largely underpinned by long-term contracts across all sectors with a geographically diverse customer base of municipal councils, hospitals, infrastructure, resources, commercial and industrial customers.
Key Fundamental Drivers
Benefiting from a Stronger Competitive Advantage
After a number of years building out its infrastructure base, CWY is extremely well positioned to benefit from a number of expected tailwinds driving the waste management industry over the medium to longer term.
Notably, an increased focus on the management of waste by government, companies and consumers. A shift to a circular economy and the banning of waste exports will likely be meaningful long-term positives for national, vertically integrated scale operators like CWY. This would be at the expense of smaller operators with limited access to capital and exposure to only some segments of the value chain.
EBITDA Margins Tracking Towards Medium Term Targets
EBITDA margins in all divisions are expected to improve in 2H22, given that margin headwinds experienced in 1H22 are seen as temporary. Further, the SWS division will be further assisted by the inclusion of a full period of the higher margin post-collection Suez assets. In context, EBITDA margins for the Suez acquisition are far higher than the broader CWY group. This reflects the concentration of landfills in the earnings mix. Further, margin recovery will be dependent upon a pass-through of rising costs.
Importantly, under ‘business as usual’ operating conditions, EBITDA margins are tracking towards medium term targets. While these targets were not re-affirmed at the 1H22 results release, or referenced in the results presentation, the stated targets at the time of the FY21 results were: i) 29.0%-29.5% for the Solid Waste Services division (1H22: 25.1%, FY21: 27.5%), ii) 15.5%-16.0% for the Industrial and Waste Services division (1H22: 14.5%, FY21: 15.7%), and iii) 21.5%-22.0% for the Liquid Waste & Health Services, division (1H22: 19.2%, FY21: 21.5%).
Waste-To-Energy Strategy Underpins Long-Term Earnings Growth Potential
At the 1H22 results release, CWY outlined a new Waste-to-Energy strategy, ‘BluePrint 2030’. The benefits from the new strategy include: i) Growing infrastructure assets, ii) Improving integrated services and market share and iii) Expanding margins.
The significance of the Waste-to-Energy strategy overall is that it represents the next leg of earnings growth for the Company, having successfully expanded the revenue & earnings base via recent years via Merger & Acquisitions, which are still expected to contribute to growth on the short term.
Recent acquisitions have resulted in revenue growth of ~7% over the course of FY21-23 on a CAGR basis. In the absence of any further acquisitions (which are considered unlikely given the Company’s focus on (and potential risk from) its Waste-to-Energy strategy), revenue growth is likely to normalise back to ~3%. This would be in line with the defensive characteristics of waste volumes that have typically generated growth rates in line with the rate of growth for GDP.
There are risks to the strategy. These could include potential delays from the permitting/approval process, CAPEX intensity, and funding options. However, it is worth noting that CWY has already made significant progress on its Waste-to-Energy strategy. We expect the Company to be prudent in terms of selecting sites and managing stakeholder relationships to reduce the potential risks.
Gearing Slightly Elevated but Expected to Trend Lower
Gearing (on a net debt to EBITDA basis) remains slightly above the ~2x level that the Company has previously indicated would be a ‘comfortable’ gearing level. However, it is well within covenant limits of less than 3.00x. Importantly, gearing is expected to return to pre-acquisition levels in FY24 (~1.6x), supported by typically strong levels of operating cashflow and CAPEX discipline (where high rates of return are expected on growth CAPEX). Further, interest cover is very comfortable, at ~20x as at 1H22.
While the shares have re-rated from a 1-year forward P/E multiple of ~30x since our last report, to 33x currently, the shares remain appealing in the context of: i) An EPS growth profile of ~14% over FY21-24 on a CAGR basis and ii) The usual premium at which the shares trade.
A key catalyst for a further re-rating in the shares is if the market assesses the risk/return profile from the Waste-to-Energy strategy to be more favourable.
In our report 3 weeks ago, we commented that “if we get a push above $2.90, preferably $3, then we can be more confident that CWY is ready to resume its uptrend.” Now that CWY is trading above $3, it has stopped short of the January high. However, it is just congesting here and it looks ready to rally again. A break above the January high will be the next buy signal.
Michael Gable is managing director of Fairmont Equities.
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