Time to move on from defensive Cleanaway

We recently researched Cleanaway Waste Management (ASX:CWY) in The Dynamic Investor after the Company released results for the six months to 31 December 2023 (1H24). The shares have been range-bound for the last three years. However, the outlook is improving. Operating leverage is expected to expand and the Company remains on target to achieve its FY26 EBIT minimum target.

With this in mind, we consider whether are enough catalysts for a re-rating in the shares.

About Cleanaway Waste Management

Cleanaway Waste Management is an Australian-focused industrial, waste and environmental services company. CWY operates in three segments: Solid Waste Services, Liquid Waste & Health Services, and Industrial & Waste Services. These three segments encompass ten strategic business units.

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. Industrial & 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. There is also a geographically-diverse customer base of municipal councils, hospitals, infrastructure, resources, commercial and industrial customers.

Key Fundamental Drivers

Pricing Power Evident in Solid Waste Services Segment

The SWS segment reported a 28% increase in EBIT to $159m. This result was accompanied by a +162 basis points increase in Solid Waste Services’ underlying EBITDA margin. This was an impressive result when considering that landfill volumes declined by 10% – indicating strong earnings leverage to price increases.

The Company’s pricing strategy targets maximising higher value waste and minimising lower value waste. This strategy is not only beneficial as it generates higher pricing, but also in extending the life of the asset reducing amortisation and delaying development CAPEX.

Potential for Margin Recovery in Liquid Waste & Health Services Segment

The Liquid Waste & Health Services segment has been impacted negatively by several factors. These include lighter-weight, lower-margin COVID-19 waste and a ramp-up in competition in Collections. In addition, the Post Collections network in Victoria has seen extended outages following facility fires.

The EBITDA margin recovery opportunity for the segment remains considerable. In particular, the newly installed autoclave units in Victoria (moving from one hammer mill to two autoclave units) can deliver additional capacity. In support, this would support operating leverage and earnings diversity for the segment.

Group Margin Expansion Still Expected

By way of background, labour availability (and the associated rising costs) presented a challenge for the Company through FY22 and into 1H23. Vacancy rates (mainly truck drivers/blue collar labour) started to improve in 2H22.

Following a period of pronounced network disruption over FY23, cost pressures are stabilising. Headcount trends, vacancies and staff turnover are improving. However, there is some caution on the cost outlook given a number of enterprise agreements have expired and are likely to be renewed at higher rates given the inflationary impact.

Overall, we continue to expect further group margin recovery in FY24/25, as:

i) Labour conditions continue to normalise,
ii) CWY generates further synergies from recent acquisitions and continued benefits from ‘Operational Excellence’ initiatives announced in late November 2022 as part of the Blueprint 2030 strategy,
iii) The impacts of inflation and higher interest rates taper over FY24. In turn, which would allow CWY to pass through cost inflation through multiple mechanisms built into large (and long-dated) customer contracts.

Underlying margin for the Solid Waste Services segment over the medium term is expected to be supported by several factors. These include improved operating efficiency, a reversal of input cost pressure from labour and fuel.

Fundamental View

Overall, we struggle to see any catalysts for a re-rating in the shares.

CWY is still currently trading on a 1-year forward P/E multiple of ~29x, which places the multiple towards the mid-point of the trading range over the last three years. The market is currently factoring in EBIT forecasts for FY26 above management’s target. However, based on our forecasts, there has been a reduction in the quantum of margin expansion expected for each of the core operating segments.

In turn, this means that medium-term earnings growth is becoming increasingly reliant on the Company generating higher investment returns on additional CAPEX, as well as further synergies from recent acquisitions – as opposed to any meaningful improvement in operational performance.

Charting View

Since breaking the uptrend in early 2022, Cleanaway has been trading sideways with a clear resistance level near $2.80. A break above $2.80 will be the next buy trigger for CWY. Investors are therefore advised to wait on the sidelines for a catalyst that could push CWY above that level before buying.

Cleanaway Waste Management (ASX:CWY) weekly chart
Cleanaway Waste Management (ASX:CWY) weekly chart


Michael Gable is managing director of Fairmont Equities.


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