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Date : 24/08/2022

Cleanaway Waste Management

ASX :

CWY

Market Cap : $5.54 Billion

Dividend Per Share : $0.048

Dividend Yield : 1.82 %

Buy

52 Week Range : $2.51 - $3.31

Share Price : $2.76

Cleanaway is the market leader and continues to grow through acquisitions. It is a top quality defensive stock. We recommend a 'Buy'

Company Analysis

Cleanaway Waste Management (ASX: CWY) is Australia’s largest waste management business, and it reported strong revenues across all its businesses for FY22. However, the costs associated with the acquisition and integration of the Sydney Resource Network, New Chum landfill rectification post floods, leadership transition and equipment loss in the Health Services business have weighed on the bottom line, leading CWY to report a Statutory Net Profit of $80.6 million, down 45.6% on last year.

ASX-100 listed CWY is a very reliable and stable business. It is a defensive stock for uncertain times. Underpinning the stability in its business is CWY’s revenue stream. The solid waste services segment makes up about 70% of CWY’s total revenues, while the rest is distributed among the Industrial Waste and Liquid Waste segments.

In the past, Australia has been seen sending rubbish overseas for disposal. However, now we are starting to dispose of more locally. This creates a structural change in the waste industry. Cleanaway has a first mover advantage and is positioned exceptionally well with a market-leading position, fleet of vehicles, major land assets, and contracts with local councils and enterprises.

Importantly, the solid waste segment is the highest margin business among all of CWY’s segments, and CWY also has the largest market share in the business. They cater to over 100,000 commercial & industrial (C&I) customers and over 100 municipal council customers. Contracts with government organisations are also long, making revenues extremely predictable and stable.

FY22 Financial Performance

FY22 was a challenging year, with inflationary costs going up. CWY was able to pass on some of the costs to customers. However, the business was still impacted. For instance, as fuel costs increased, CWY offset part of the increased cost by adding a fuel surcharge. Given their market dominance and strong customer mix, it positions CWY better than most businesses when mitigating the financial impacts of inflationary costs.

Remember, in these challenging times, we need to look for a business that is relatively better than its peers, as there is no business out there are remains completely unaffected.

For FY22, net revenue of $2.6 billion was 18.4% higher than the pcp, with higher revenue across all segments primarily driven by a general recovery in economic conditions, new customer contracts, recent acquisitions, and pandemic-related clinical waste, and higher commodity revenue.

Underlying EBITDA of $581.6 million was 8.7% higher than the pcp, reflecting the contribution from SRN, new customer contracts and commodities partially offset by lower volumes from New Chum landfill, higher fuel prices, COVID-19-related impacts – particularly in the Health Services business, floods, and labour availability.

The underlying EBIT of $257.1 million was 0.6% lower than the pcp, largely due to increased depreciation and amortisation expenses related to the SRN acquisition. Underlying earnings per share attributable to ordinary equity holders of 7.0 cents per share was 4.1% lower than the pcp.

Net cash from operating activities increased by $41.9 million to $466.3 million compared to FY21, reflecting increased underlying EBITDA and lower tax payments, partially offset by cash outflows attributable to underlying adjustments and higher interest payments. This resulted in a strong cash conversion ratio of 99.9%.

Dividend

The Board declared a final unfranked dividend of 2.45 cps taking the full year dividend to 4.90 cps, 6.5% higher than the pcp.

This takes the total dividends for the year to 4.90 cents per share (pcp: 4.60 cents per share). The dividend will be unfranked and paid on 7 October 2022 to shareholders on the register on 23 September 2022.

Cleanaway is eligible to participate in the Commonwealth Government’s Instant Asset Write-Off Scheme, which is forecast to reduce tax payments made by the Group in FY22, FY23 and FY24. Because of lower tax payments from the Instant Asset Write-Off Scheme, Cleanaway does not expect to resume franking dividends fully until December 2024.

Company Updates

Cleanaway is refreshing its strategy to meet the evolving and emerging opportunities that will come from transitioning to a high circularity and low-carbon economy.

After years of low Inflation, we saw inflation increase sharply across the economy. There are several reasons for this, including supply chain constraints, the war in Ukraine and the wider economic impacts of the pandemic. One of the largest contributors to rising operating costs has been fuel, with the oil price has risen dramatically over the year.

While Cleanaway is not immune to inflationary pressures, the company’s CEO Mark Schubert added that they have mechanisms within many of their contracts that allow us to recoup rising costs over time. CWY has a time lag in their ability to recover these amounts, which has resulted in a temporary impact on margins.

Operational Performance

Solid Waste Services

Solid Waste Services (SWS) net revenue increased 23.2% or $342.3 million to $1,818.6 million. Underlying EBITDA increased 15.8% or $63.9 million to $469.4 million, and underlying EBIT increased $14.8 million to $227.8 million.

CWY completed the acquisition of the Sydney Resource Network from Suez on 18 December 2021, and their integration team quickly onboarded ~100 new employees. The integration team has ensured a seamless transition for customers and Cleanaway. This has been completed with a full operational handover to the NSW business unit in February.

The assets contributed $127.5 million in net revenue and $57.7 million in EBITDA during the period. CWY also benefits from enhanced operating leverage through expanded footprint and route optimisation. They expect to extract further synergies through leveraging the network, licences, and land to accelerate the progress of CWY’s organics and C&D blueprints in NSW.

Solid Waste Services revenue benefited from an initial contribution from the Sydney Resource Network assets, new municipal collection and post-collections contracts, higher commodity prices and a full-year contribution from the Perth MRF. This was partially offset by the impacts of COIVD lockdowns (in particular, NSW), reduced contributions from flood-affected regions and the lower volumes into the New Chum landfill.

In addition to costs associated with new assets and contracts, higher operating costs were driven mainly by significantly higher diesel prices, higher working costs in flood-affected regions and higher index-linked commodity rebates and shipping costs. Labour costs were higher due to greater use of overtime, sub-contractors, and provision of pandemic leave.

Underlying EBITDA increased 15.8%, while underlying EBITDA margins decreased 170bps across the year, reflecting several factors including higher diesel prices, lower commodity margins, higher COVID-19-related labour costs (pandemic leave and temporary labour), lower average landfill margins (ex SRN) resulting from the lower volumes into New Chum and the impacts of the floods in New South Wales and Queensland. The initial contribution from SRN partially offset this.

Coles also awarded Cleanaway the Supplier Service champion of the year for supporting its landfill diversion goal. The significant flood events and damage to cells at the New Chum landfill during the year resulted in a decision to temporarily close the landfill until rectification work was completed. This is expected to be completed over the course of FY23.

Liquid Waste & Health Services

Liquid Waste & Health Services revenue increased 7.4% to $550.5 million, while underlying EBITDA decreased 12.5% to $96.2 million. Consequently, underlying EBITDA margins decreased 400 basis points to 17.5%. Underlying EBIT decreased 21.6% to $53.0 million, and underlying EBIT margins decreased 380 basis points to 9.6%.

The Liquids and Technical Services (LTS) business realised 9% higher revenue and 6% higher EBITDA than the pcp predominantly due to a strong recovery in QLD, and significant work on the Tottenham (now complete), Kaniva and Parramatta Light Rail projects. An increased cost of disposal partially offset this in NSW, capacity constraints due to labour availability and higher fuel and labour costs. CWY is exploring opportunities to treat more complex waste streams and working collaboratively with clients on potential future issues and how CWY can support them.

From an underlying EBITDA perspective, the Hydrocarbons business performed in line with the prior year. Revenue increased 8%, benefitting from higher post collections volumes and prices, and higher Cleanaway Equipment Services revenue from increased machine sales and growth in servicing activity.

This was offset by higher natural gas and diesel input costs, higher freight and labour costs, and the non-recurrence of the temporary increase in product stewardship receipts for high-quality recycled base oil.

The Health Services business revenue increased by 12% while underlying EBITDA decreased by 36%. Higher revenue was largely attributable to increased clinical and general waste at health care facilities (hospitals, labs, aged care facilities, hotel quarantine and testing centres) because of the pandemic. There was also an increase in biosecurity waste as borders reopened and sharps collectors from vaccination centres and hospitals.

The significant increase in the volume of waste and the associated increase in services caused by COVID-19, coupled with the need to maintain this critical health service led to significant inefficiency and additional costs in health collections and post collections infrastructure. In collections, additional labour and hire vehicles were required to perform the extra services. Additional operational labour was required for increased receptacle management and treatment in processing. In disposal, additional costs were incurred from using the third-party infrastructure. In waste movement, the intra-business sub-contracted freight costs to move waste interstate to ensure that CWY remains within site licence limits further added to costs. This was further exacerbated during the second half of the year by two incidences that resulted in damage to and the loss of waste processing equipment.

Industrial & Waste Services

Industrial & Waste Services (IWS) reported an underlying EBITDA of $47.2 million, which is 1.7% lower than FY21. The underlying EBITDA margin at 14.4% was 130 bps lower than FY21. The segment performed well in challenging external market circumstances. The compression in underlying EBITDA margin reflected higher unit labour costs and costs to cover pandemic leave, higher fuel costs and fewer higher margin infrastructure projects in Queensland and Victoria, which were delayed due to COVID-19. This was partially offset by a strong performance in the Western Australian, South Australian and Northern Territory markets, less affected by COVID-19 during the year.

Underlying EBIT decreased by $2.7 million to $19.9 million, and underlying EBIT margin decreased 130bps to 6.1%, reflecting the underlying EBITDA outcome and accelerated depreciation of some legacy lease payouts. During the year, IWS re-signed available contract extensions with a 100% renewal rate and progressively improved its new business win rate. Inflationary pressures, particularly fuel costs, have compounded COVID-19 impacts, and CWY expects labour rate pressures to follow. The nature of CWY’s business means that these higher costs will be directly reflected in the pricing of new contracts.

The highly competitive infrastructure segment remains buoyant with opportunities to participate in large Government funded projects. Opportunities in the Mining/Mineral processing and Oil & Gas segments continue to have a positive outlook, with the larger contract and project opportunities more suited to the larger Tier 1 national provider like IWS.

Indigenous participation is an increasingly important consideration for Tier 1 resource companies, who seek to ensure their efforts in this area result in direct financial benefits to indigenous people and businesses. The Pilbara Environmental Services joint venture between Cleanaway and King Kira Group (a female indigenous-owned business) will be well placed to participate in the next wave of Industrial Services contracts starting in northwest WA. IWS continues to deliver organic growth from its existing client base (resigns, increasing scope of services and market share) plus new business across the regions, with the outlook for sustainable growth over the next few years supported by a healthy pipeline of work. This pipeline continues to be developed and balanced across the key segments in which CWY operates. The firm expects to see its segment portfolio shift from a historical mining segment bias to a greater share of the oil & gas segment, given the current activity In the sector, with several material opportunities being tendered and awarded during FY23.

During the year, IWS led a cross-segment collaboration with the SWS segment to tender for and win a Bechtel awarded a 4-year contract on Woodside’s Pluto LNG site. The vertical capability that Cleanaway can provide, together with Bechtel’s prior engagement and experience of IWS, were significant contributing factors to the successful tender.

IWS also secured the first tranche of ExxonMobil’s decommissioning tank cleaning work at its Altona plant. It is well positioned to extend the contract and leverage its capabilities into additional workstreams. Furthermore, a significant opportunity is related to decommissioning ageing oil and gas assets. Much of Australia’s onshore and offshore oil and gas infrastructure is approaching the end of its productive life, leading to a significant forecast ramp-up in decommissioning activity through the next decade and beyond. The total cost will be an estimated $50 billion.

Investment Thesis

Cleanaway is a very stable business and a market leader in its area of operation. Since they already have a very high market share, CWY’s growth strategy is driven by acquisitions.

Cleanaway is hard at work on ‘Blueprint 2030’, a strategic infrastructure growth plan the company has outlined that will yield long-term shareholder value.

Blueprint 2030

Cleanaway is looking to create superior shareholder value by integrating and extending its leading network of infrastructure assets to provide high circularity, low-carbon solutions, seamless service, and value for money for its customers.

The blueprint is to leverage infrastructure assets to create the best possible sustainable solution for their customers. It is a flywheel strategy that will ultimately increase cashflows and shareholder returns in the long term.

As part of the infrastructure growth plan, Cleanaway will Invest strategically to extend its infrastructure and services platforms. It will enable the firm to capture value from waste industry transition and decarbonisation. The business areas Cleanaway is actively pursuing are:

  • Energy from waste
  • Construction and demolition
  • Organics Landfill optimisation
  • Core infrastructure expansion
  • Innovation

The waste industry plays a central role in the low-carbon and sustainable world of the future. This strategy by Cleanaway is proactive and should position the firm well for the future. This means a significant investment will be going towards this initiative, which has already begun.

Equity Raising to fund Acquisition

Along with announcing FY22 results on 18 August, Cleanaway also launched a $350 million fully underwritten institutional placement and a $50 million non-underwritten share purchase plan. The issue price of the offer is $2.50 a share, completed on 22 August.

The Equity Raising proceeds will provide significant balance sheet capacity to fund Cleanaway’s BluePrint 2030 strategy. This includes medium-term opportunities to deliver the blueprints under the Strategic Infrastructure Growth and Sustainable Customer Solutions pillars1, starting with acquiring a 100% interest in Global Renewables Holdings Pty Ltd (GRL) for $168.5 million.

With the completion of the placement, the SPP has now opened up to eligible shareholders. New shares are issued at the same price of $2.50 a share, with applications beginning on 22 August and closing on 12 September.

The GRL Acquisition

Cleanaway announced that it had signed an unconditional agreement to acquire a 100% interest in GRL for $168.5 million. The acquisition of GRL accelerates Cleanaway’s BluePrint 2030 organics strategy by providing high circularity, low-carbon solutions for ‘Red bin’ mixed waste today and future FOGO bin waste. The acquisition is expected to complete this quarter.

GRL is a New South Wales Environment Protection Agency licensed large-scale organics composting facility that processes 220kT p.a. or ~20% of Sydney’s mixed household waste from its strategically located site in Western Sydney.

Cleanaway is the exclusive contracted waste provider to the GRL facility until 2032, with waste supply underpinned by contracts with surrounding Councils, with whom they have existing long-term relationships.

The facility provides sustainable customer solutions today by delivering 30% landfill diversion and better carbon outcomes than Red bin waste sent directly to landfill. As the market transitions to FOGO solutions, the GRL facility is expected to deliver even greater diversion rates and carbon outcomes from FOGO feedstock.

CWY plans to operate two strategically located sites to provide Sydney-wide processing capability for organics:

  • GRL’s licensed large-scale organic composting infrastructure is in a strategic location
  • An enclosed FOGO composting infrastructure at the existing Lucas Heights garden organics site

The acquisition unlocks Kemps Creek for potential redevelopment into a C&D resource recovery facility to replace the existing mixed waste organics processing, with organics processing consolidated at GRL and Lucas Heights.

CWY well placed for change in Government Policy

Customer demand and government policy are driving a shift to greater resource recovery and diversion from landfill. Food organics and garden organics separation is the next phase in the transition towards delivering landfill diversion targets. Under NSW Government policy, households and certain C&I businesses will be offered a new collection service by 2030 where both food and garden organic waste will be collected in the FOGO bin. Processing of this FOGO bin requires a new indoor composting infrastructure. GRL’s composting facility composts organics from the Red bin and will gradually transition to FOGO bin feedstock as Councils introduce the new service.

The GRL acquisition gives Cleanaway first mover advantage in Australia’s evolving waste management industry.

Strategic Rationale of the Acquisition:

  • Accelerates Cleanaway’s BluePrint 2030 organics strategy by providing high circularity, low-carbon solutions for ‘Red bin’ household waste today and FOGO bin organic waste as Council customers transition to this solution
  • Opportunity to immediately internalise existing volumes and acquire an attractive pro forma FY22 EBITDA of ~$21.4 million
  • Acquisition of GRL eliminates an unfavourable contract provision for Cleanaway concerning GRL under which payments to GRL exceeded receipts from Councils (the contract was acquired as part of the acquisition of the Sydney Resource Network from Suez, for which a purchase price reduction was obtained)
  • GRL provides an established and licensed composting platform and a highly capable and experienced management team
  • Site location and licences to process mixed waste and FOGO are of significant importance to the Sydney region and would be difficult to replicate on a greenfield basis
  • Allows Cleanaway to leverage its geographically diverse Sydney network to capture organics share, with GRL and a further planned Lucas Heights facility providing Sydney-wide processing capability.

GRL is expected to contribute a pro forma EBITDA of ~$21.4m, which reflects: GRL’s Reported EBITDA of ~$28.6m; fewer Cleanaway’s ~$5.9m annualised loss on the GRL unfavourable contract; this amount is currently included as a reduction to the balance sheet provision and will go to P&L post-acquisition; less – $1.4m associated with the volume the facility processed above its 220kT p.a. licensed capacity in FY22A.

Balance Sheet

Supporting the growth in FY23 and the Blueprint 2030 is CWY’s balance sheet. While CWY is leveraged, it is not at any risk of defaults.

  • CWY has $66 million in cash at the end of FY22,
  • As of 30 June 2022, the Group had $454 million of headroom under committed debt facilities,
  • $500 million 3‐year committed debt facility utilised for purchase of SRN
  • Leverage ratio of 2.23x in line with expectations
  • The gearing ratio was 38.7% on 30 June 2022 (28.2% on 30 June 2021)
  • The next refinancing is not due until July 2024
  • The Group remains comfortably within its leverage ratio and interest cover ratio covenant limits

Following the recent equity raise, Cleanaway is utilising $174 million to bolster its balance sheet capacity.

FY23 Outlook

FY23 earnings are expected to be higher than FY22 due to a full-year contribution from SRN, underlying growth, and Blueprint 2030 initiatives.

CWY expects FY23 underlying EBITDA to be in the range of $630-670 million. Based on current operating conditions and a balanced assessment of the opportunities and risks, the business is tracking towards the mid-point of this range.

This excludes the ~$21m annualised EBITDA contribution from the GRL acquisition. The material factors influencing the outcome are volumes into post collections assets and labour availability. The guidance assumes no material change to prevailing market and economic conditions. Depreciation and amortisation (excluding GRL) are expected to be ~$360 – $370 million.


Source: CWY

By acquiring GRL, Cleanaway has boosted its growth outlook in metro Sydney. Only a few Councils currently offer FOGO collections, and volumes are a small part of the overall market. As existing contracts roll off, Councils are expected to transition from no source separated organics or from garden organics only to FOGO. The improved source separation is expected to see the overall organics market in Sydney double to over 700kT once all Councils have completed the transition.

Cleanaway, including GRL, currently processes over 600kT of Red bin and Green bin waste from 15 Sydney Councils – these Councils are estimated to generate ~350kT of FOGO after the transition. The market size combined with the existing relationships and transfer station network will support CWY’s planned investment in FOGO at Lucas Heights and the GRL facility.

Recommendation

Cleanaway is a rock-solid business with stable revenues and cashflows that are underpinned by lengthy contracts with municipal councils and enterprises. They have the first mover advantage in a changing landscape in Australia’s waste management industry and command a market-leading position in all areas of operation. The company is growing by consistently acquiring competitive businesses, strengthening its competitive position and ensuring stability in an uncertain environment. FY22 results have come in as expected, with all business areas seeing material revenue growth. Cleanaway is now raising capital to fund another acquisition and strengthen its balance sheet. We recommend investors to ‘Buy‘ and eligible shareholders to participate in the Share Purchase Plan.

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