In the current market environment, it is worth being invested in a company that has not only seen its share price hold up well, but has the potential to head higher when the market settles down. Cleanaway Waste Management (ASX:CWY) is one such company.
On 19 February this year, Cleanaway’s half year results (1H20) surprised the market. This led to the share price jumping 16 per cent on the day. Reported earnings exceeded market expectations, which were low heading into the interim result. This was given the confluence of bushfires, coronavirus, plant fires, and weak commodity prices. At the AGM in October 2019, prior to the release of the interim results, the Company had guided for flat earnings growth 1H20.
One of the key positives from the result was that the Company clarified the impact on earnings from its exposure to commodity prices. It ended up being less than what most in the market thought it would be. This also highlights the benefits of CWY’s largely vertically-integrated business model that enables the Company to mitigate volume/cost pressures.
While the clarification removed a significant overhang for the shares, we assess the extent to which other factors have contributed to an improving profile for CWY’s fundamentals.
CWY’s main business is the collection, recovery, and disposal of solid waste. These operations comprise the Solid Waste Services segment, which accounts for over 70% of operating earnings and over 60% of net revenue. This segment also generates the highest margin. The Company’s other operations include:
• The collection, treatment, processing, refining and recycling and destruction of hazardous and non-hazardous liquids, hydrocarbons and chemical waste, specialised product destruction, hazardous waste and e-waste.
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• The provision of services to the health sector for the safe treatment and disposal of health-related waste. This includes sharps management, medical waste, pharmaceutical waste, healthcare hazardous waste and quarantine waste.
• Services to the Infrastructure, Industrial and Resources markets. These include drain cleaning, non-destructive digging, vacuum loading, high pressure cleaning, pipeline maintenance and CCTV.
Concerns About Commodities Exposure Overdone
A major concern for investors leading into the result had been the continued decline in recycled commodity prices, particularly in old corrugated cardboard (OCC), and the impact it would have on CWY’s earnings. This is because these are high margin revenues and as such would flow directly through to net profit. Commodity prices, namely OCC/paper, have been weak internationally, but appear to have held up well locally.
At the 1H20 results release, the Company disclosed that its commodity exposure accounted for 3.3% of group net revenue (from 9.5% in 1H18) or 5% of net revenue for the Solid Waste Services segment. Further, CWY has been able to mitigate the impact of declining commodity prices by reduced customer rebates and increased collection charges.
The implication from a lower-than-expected leverage to commodities is that, together with other cost control measures, the Company is likely to achieve its EBITDA margin of 27-28% earlier than expected. In context, EBITDA margin in 1H20 was ~25%. Without the negative drag of lower commodity prices, as well as a landfill levy in Queensland on 1 July 2019 which resulted in reduced landfill volumes in Queensland, the EBITDA margin in 1H20 could have approached the 27-28% target.
Strong Pipeline of Opportunities Support Earnings Growth
There are currently a number of projects in the pipeline that are likely to support earnings growth commencing in FY21. These are in addition to regular contract wins and cost control measures for each of the three segments. The projects include:
1. The acquisition of SKM Recycling Group and Statewide Recycling Services during 1H20. This has expanded the Company’s footprint across Victoria, Tasmania, and South Australia. CWY expects SKM sites to handle 200,000tpa for optimal operation with earnings contributions from SKM and Statewide to ramp up in FY21.
2. CWY announced a plan to build a plastic pelletising plant in Albury/Wodonga (NSW) with 28,000tpa of capacity in partnership with Pact Group and Asahi. The plant will be focused on processing plastics into high quality, food grade raw materials for use in packaging. CWY will be undertaking collection and sorting activities. As the facility is expected to be operational by December 2021, this investment is expected to contribute to earnings in FY22.
3. The Company acquired a 51% interest in an entity which holds the investment in the Energy from Waste project in Eastern Creek (Sydney). The proposed project will entail development of an 8ha site within the waste and industrial precinct. The project is designed to convert 500,000tpa of waste feedstock to generate 45MW of baseload power. CWY estimates ~95% of incoming waste to the proposed plant will be diverted from landfills. The contribution to earnings from this project is expected from FY23 onwards.
Balance Sheet Provides Scope to Pursue Growth Opportunities
Notwithstanding the increase in gearing (on a net debt to EBITDA basis) from 1.4x as at 30 June 2019 to 1.6x as at 31 December 2019, the gearing level remains strong and below the ~2x level that the Company has previously indicated would be a ‘comfortable’ gearing level.
In addition, CWY issued US$270m in US Private Placement (USPP) notes in February 2020, which extended the average debt maturity and increased the debt headroom to ~$375m, giving CWY additional flexibility to pursue growth opportunities.
Charting View of Cleanaway
The $2.20 region had offered strong resistance to CWY in the past, so it is significant that their recent results saw it break through that level straight away and close on the highs. It then met with selling near the 2019 high, but that is normal. In the last week we have seen it fall back due to the panic selling in the broader market. Again, that is normal, but it is a bullish sign to not only see it hold up well against the market, but for strong buying to come back in as soon as it got near $2. CWY shares are therefore showing some very defensive characteristics which means that any downside from here is likely to be limited. Longer term, once the market settles down, we believe that CWY shares can head higher.
Michael Gable is managing director of Fairmont Equities.
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