The defensive nature of the earnings for Cleanaway Waste Management (ASX:CWY) has investment appeal in light of current market conditions. However, investor sentiment continues to oscillate shorter-term between the earnings impact from higher cost pressure and the medium-term earnings growth opportunities from the Waste-to-Energy strategy. The share price has held up reasonably well amidst the market volatility over the last few months, but have recently hovered towards the lower end of its recent trading range. With this in mind, we recently researched Cleanaway Waste Management in The Dynamic Investor to assess the prospects for a re-rating.
About Cleanaway Waste Management
Cleanaway Waste Management is an Australian-focused industrial, waste and environmental services company, which operates in three segments: Solid Waste Services, 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. They have a geographically diverse customer base of municipal councils, hospitals, infrastructure, resources, commercial and industrial customers.
Key Fundamental Drivers
Can Earnings Guidance be Achieved Given Cost Pressures?
The Company provided EBITDA guidance of $630-670m for FY23 (FY22: $581.6m). It was underpinned by a full-year contribution from the acquisition of Sydney Resource Network (SRN) in December 2021, organic growth and initiatives around the BluePrint 2030 Strategy. The main swing factors regarding the EBITDA guidance are volumes through high margin post-collection volumes (especially SRN in Sydney and MRL in Melbourne) and cost pressures.
In relation to the latter, the Company faced cost pressures in FY22. This contributed to a 200 basis point decline in EBITDA margin to 22.3%. The major contributing factor to cost pressures in FY22 was labour shortages, which is likely to continue into FY23.
Modest EBITDA Margin Recovery Over the Medium Term
As a consequence of the increasing cost pressures, the Company has stepped away from the medium-term EBITDA margin targets they were guiding investors to previously. The stated targets at the time of the FY21 results were: i) 29.0%-29.5% for the Solid Waste Services segment, ii) 15.5%-16.0% for the Industrial and Waste Services segment, and iii) 21.5%-22.0% for the Liquid Waste & Health Services segment. Since FY20, EBITDA margin for each of the segments has declined relative to the prior targets.
Overall, we expect modest EBITDA margin recovery over the medium term. On the one hand, improved operational efficiency, higher margin post-COVID contracts in the health business and large SWS customers contracting at a higher inflation adjusted price are all factors supporting EBITDA margin expansion. However, persistent staff shortages and inefficiencies from the high rate of staff turnover are expected to limit the degree of EBITDA margin expansion at a group level over the medium term.
BLUEPRINT 2030 Strategy Taking Shape
CWY outlined its new Waste-to-Energy strategy, ‘BluePrint 2030’ in February 2022. 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 in the short term.
Concurrent with the FY22 results release, CWY announced an equity raising (comprising an $350m underwritten institutional placement and $50m Share Purchase Plan which were completed over August and September 2022) to provide balance sheet capacity to support the BluePrint 2030 strategy. The majority of the funds raised were used to acquire Global Renewables Holdings (GRL) for $168.5m. The deal is expected to be EPS accretive by ~4-5% on a pro-forma FY22 basis.
Further Acquisitions on the Agenda
Aside from the GRL acquisition, the equity raising provides capacity to pursue further growth opportunities, given that gearing is expected to decline from 2.2x as at 30 June 2022 to 1.9x post-acquisition (and below the target gearing range of 2.0-2.5x and the covenant limits of less than 3.0x).
Overall, the balance sheet remains in strong shape, with gearing expected to decline further from the post-acquisition level of 1.9x given the typically strong levels of operating cashflow and CAPEX discipline (where high rates of return are expected on growth CAPEX). Further, the next debt refinancing not due until July 2024.
As at 30 June 2022, CWY had $454m of headroom under its committed debt facilities. Following the GRL acquisition, the remaining balance sheet capacity is estimated to be ~$250m, which will enable the Company to undertake further investment ($40-50m) in GRL over time, as well as pursue tenders alongside potential recycling developments at SRN landfills.
Fundamental View
CWY shares are currently trading on a 1-year forward P/E multiple of ~31x, which is towards the top end of both its recent trading range and the usual premium at which the shares trade; and reflect the highly defensive nature of the Company’s earnings. While the EPS growth profile remains attractive (~14% over FY22-25 on a CAGR basis), we consider that earnings growth over the short term (consensus EPS growth forecast of +8% for FY23) are at higher risk given increased cost pressure in the business, which in turn has increased the uncertainty regarding the extent and timing of a recovery in EBITDA margin for each segment.
Importantly, we contend that investor focus on the shorter-term earnings impact from higher costs is likely to be outweigh the medium-term earnings growth opportunities from the Waste-to-Energy strategy, which is still playing out and in need of further scale via additional acquisitions and funding. Regarding the latter, it is worth noting that the recent equity raising does not cover funding for potential Waste-to-Energy projects and as such, further equity raisings are an overhang for the shares.
Charting View
CWY has broken the uptrend that was in place since 2020 and price action is now looking bearish. At the very least, it will need to find support at the June low near $2.50. However, if that breaks, then we would expect lower levels. Investors in CWY can therefore wait for an opportunity to get in at much cheaper prices.
Michael Gable is managing director of Fairmont Equities.
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