We recently assessed the fundamentals for Cleanaway Waste Management (ASX:CWY) after the Company reported its full-year results (FY19). CWY’s main operations comprise the collection, recovery and disposal of solid waste as well as liquid waste.
Post results release, the share price has struggled. The underlying earnings result (EBITDA) was slightly below consensus estimates. Also, the FY19 result was the first in a while where the Company has not delivered a result that was ahead of market expectations. Further compounding this is that the Company downgraded EBITDA guidance for FY20. This was surprisingly below market expectations.
Upside Factors to FY20 EBITDA Guidance
CWY (who typically provide qualitative guidance) commented at the FY19 results release that it expects underlying FY20 EBITDA growth to “moderate slightly from current market expectations”. In contrast, consensus estimates had factored in ~11% EBITDA growth. The hit to earnings is attributable to a number of factors, including the China National Sword Policy*, lower commodity prices and the lack of ramp-up in the Resource Recovery facility. This has been impacted by a slower-than-expected level of acceptance of contaminated recyclables in foreign markets.
Following broker updates to forecasts post FY19 results release, downward revisions to consensus EBITDA estimates for FY20 imply ~6% EBITDA growth in FY20. This is in excess of Company guidance for a fall of “low single digits”. So, the market appears to be factoring in a boost to FY20 EBITDA from greater than expected synergies from the Toxfree acquisition and better-than-expected pass-through of cost increases onto customers via price increases (which were only partially passed onto customers in FY19).
Lower Gearing Levels Provide Growth Opportunities
The Company is generating strong free cashflows, which underpinned a reduction in the gearing level (on a net debt to EBITDA basis) from 1.5x as at 31 December 2018 to 1.4x as at 30 June 2019. This remains below the ~2x level that the Company has previously indicated would be a ‘comfortable’ gearing level.
The gearing level is expected to decline further given solid free cash generation and relatively low dividend payments. Accordingly, the currently low cost of debt, coupled with increased balance sheet capacity, provides scope to fund growth investment (including acquisitions) and/or to undertake capital management initiatives, such as a share buyback or an increase in the dividend (given that the dividend yield is currently ~2%).
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However, we expect the Company would prioritise further acquisitions over some form of capital management given that acquisitions have remained on the agenda for some time.
Fundamental View of Cleanaway
We continue to highlight the strong fundamentals underpinning CWY. We also like the defensive nature of its earnings/cashflow, as well as the largely vertically-integrated business model and balance sheet capacity.
With the shares currently trading on a 1-year forward P/E multiple of ~26x, we would prefer to see a pullback in the share price in light of the higher earnings risk. In particular, the key earnings risk for CWY is that while the Company is making progress towards achieving its EBITDA margin targets for each of the three segments, it is worth noting that these are at risk from lower prices for recyclable commodities and higher sorting costs related to the China National Sword policy.
Further, these EBITDA margin targets were set at the 1H19 results, when the economic conditions were comparatively better and the impact from the China National Sword policy in FY19 was expected to be much lower (~$1m) than the outcome (~$5-6m).
Charting View of Cleanaway
After its FY results, we saw CWY fall back towards the February gap at $1.95 and bounce strongly off it. That is likely to be the low for CWY for the time being. However, there is a lot of resistance between $2.20 and $2.30. Therefore in the short-term, we are unlikely to see CWY push beyond that resistance level and the share price is likely to track sideways here for the time being. Once it can break through that resistance level, then we will be confident it can head higher again.
*What is the China national sword policy?
The China National Sword Policy came into effect in February 2018 to ban imports of 24 types of waste material and to set a tougher standard for contamination levels of recycled product that the Chinese government is considers acceptable.
Michael Gable is managing director of Fairmont Equities.
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