Falling share prices – An opportunity (not) to be wasted

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The Markets

This week: ASX v Wall Street

FYTD: ASX v Wall Street

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After a challenging three months in equity markets, both domestically and abroad, we have elected to take a more authoritative stance towards adding new positions in clients’ equities sub-portfolios.

As part of this process, we have decided to take profits in some of the stocks that have been subject to takeover bids. Think Costa, United Malt and further profit taking in Origin.

In turn, we continue to add higher quality mid-cap (ASX 50-150) names to the portfolio in the search for value and superior investment returns. This also is designed to protect the portfolio from illiquidity – at a challenging time in ASX history in this respect.

This week we highlight a new addition to the portfolio.

Cleanaway Waste Management (CWY)

Background

Cleanaway Waste Management (Cleanaway) is a leading provider of waste management and environmental services in Australia, operating across 200 solid, liquid and industrial service depots.

Cleanaway provides a comprehensive range of waste management services, including:

• General waste collection and disposal: collects and disposes of general waste from businesses, residences, and construction sites
• Recycling: collects and recycles a wide range of materials, including paper, cardboard, plastic, glass, and metal
• Industrial waste management: manages industrial waste, including hazardous waste, medical waste, and contaminated soil
• Resource recovery: recovers resources from waste materials, such as energy from waste incineration and compost from organic waste

Management EBIT target of $450m+ by 2026 – double-digit earnings growth

Despite an improved performance in FY23, there remains a significant opportunity for improved financial returns. Consistent with this, the company has structured its FY26 incentive scheme thresholds to include a greater than 40% improvement in EBIT to >$425m by FY26.

Management stretch targets (trigger for full incentive payments to be made to management) are set at EBIT of $500m by that stage, representing a 66% uplift).

Sources of revenue support

One of the attractions to investing in Cleanaway is that its revenue base is well placed contractually to be able to increase at a rate in excess of inflation. In addition, the Federal government’s National Waste Action Plan and the movement towards a circular economy will result in waste management solutions and be of clear benefit to Cleanaway as the largest player in the Australian waste management industry.

Australian waste management industry revenue ($bn) – (CWY has ~40% share)

Source: Barrenjoey, Company Data

Supportive Government Policy

In 2018, the Australian Government (in association with state and territory governments) established a renewed version of the National Waste Policy. The policy aims to help Australia move closer to a circular economy that eliminates waste and improves resource recovery.

As part of the policy, the 2019 National Waste Policy Action Plan established targets to achieve these goals. The list is detailed but we highlight several key features from the policy below:

National Waste Policy Action Plan – Key features –

The company also benefits from a range of environmental tailwinds and has address the opportunities this provides in its 2030 Strategy.

CWY’s Blueprint 2030 Strategy – an Environment, Sustainability and Governance (ESG) winner

The waste industry plays a key role in the transition to a low-carbon and high circularity world. Current expectations, along with a supportive regulatory environment, provide great opportunities for the company.

In 2020, Cleanaway launched its Blueprint 2030 strategy, which outlines the company’s commitment to sustainability and innovation. The strategy has three key pillars:

1. Leading the transition to a circular (more sustainable) economy: to divert 80% of waste from landfill by 2030.
2. Becoming a net zero emissions company: to achieve net zero emissions by 2050.
3. Delivering trusted, sustainable waste solutions: to be the most trusted provider of sustainable waste solutions in Australia.

The company is making significant progress towards achieving its Blueprint 2030 goals. In 2022, the company diverted 65% of waste from landfill and achieved a 30% reduction in greenhouse gas emissions.

Landfill diversion and resource recovery targets

States have also set targets to divert waste from landfill and improve resource recovery through recycling, organics processing or Energy from Waste (EfW). These policies, (along with existing landfills nearing end of life and difficulty in receiving permits for new landfills), have resulted in an increased need for investment in resource recovery facilities.

An immediate focus for state governments is Food Organics and Garden Organics (FOGO) processing which is set to roll further over the next decade.

There are 3 primary opportunities for a step change in growth in earnings over the next 5 years

1) FOGO (Food and Garden Organics)

The FOGO opportunity is underpinned by:

1. Policy tailwinds related to the mandatory rollout of FOGO collections;
2. A large existing opportunity to increase recycling rates with food waste already contributing 40-60% of volume in the red general waste bin;
3. A shortage of organics processing capacity to meet the demand following the rollout; and
4. FOGO processing requires more advanced and costly technology which should yield a higher price per tonne. Furthermore, outside of a few major players, the market is highly fragmented, representing opportunity for industry consolidation.

The current recycled organics market is 8mt, which could increase to 11mt assuming recycling rates increase following the implementation of FOGO collections. Given the shortage of processing capacity in the market, there has been increased investment and we estimate more than 1mt of capacity is currently pending approval or construction nationally (including 77kt for Cleanaway). 

Veolia is currently the leading processor of food waste organics. We estimate that Cleanaway currently has <5% market share nationally.

2) Construction & Demolition (C&D) Waste

C&D waste historically has not been the key focus for Cleanaway and we estimate that this area currently represents less than 10% of group revenues. Moving forward. Cleanaway has highlighted C&D as a key pillar for growth among its Blueprint 2030 strategy. We note recent acquisitions in the space (Grasshopper Environmental; $29m, Oct-20; and Vin Bins; $9m, Mar-22) and disclosure around the potential to repurpose and redevelop its existing facility at Kemps Creeks into a C&D resource recovery facility.

The C&D recycling market is more mature compared to FOGO and current recycling rate is high at ~76%. The C&D market can be characterised by;

1. A strong incentive to divert waste from landfill, given the heavy weight of C&D waste and increased landfill levies;
2. Difficulties in obtaining new disposal sites in key areas and concentration of disposal sites by a few competitors;
3. Relatively simple technology required for processing (washing and crushing) has allowed for an easier recycling process compared to other waste types; and
4. The construction industry in Australia has experienced substantial growth over the past decades, and C&D waste has increased significantly alongside this. In 2019, 27mt of C&D waste was generated in Australia, representing 44% of total waste.

3) Energy from Waste (EfW)

EfW is proven and used widely in other countries but is an emerging technology in Australia. There are several projects in Australia that are approved or under construction. These projects require a large upfront capital investment ($0.7-$1bn), involve lengthy approval and construction times but the contractual arrangements for feedstock and energy output reduces uncertainty. The development of EfW in Australia faces several challenges, notably:

1. regulatory barriers, particularly in NSW (we note five proposed projects were declined including Cleanaway’s Western Sydney project),
2. the inconsistency of regulation and policies regarding EfW across jurisdictions,
3. community opposition to proposed projects in certain areas, and
4. uncertainty of feedstock volumes.

Regarding Cleanaway’s positioning in this market, the company’s strong collections business represents an advantage as this secures feedstock volumes. However, compared to Veolia and Remondis, which already operate several EfW facilities globally, Cleanaway will lean on partners for such experience. Given the medium-term nature of these investments, upside is unlikely to be included in consensus forecasts prior to a formal announcement, in our view.

Waste flow

Source: State of NSW and Department of Planning, Industry and Environment

This is an another area where Australia is quite a bit behind world’s best practice.

Australia’s recycling and energy recovery rates vs select countries

Source: National Waste Report

Cost management – Less waste paper internally

Our contention is also that there are significant efficiency opportunities within the company. Currently, the workforce of Cleanaway has a heavily paper-intensive set of processes to work with. 220,000 manual work orders (4m pieces of paper) produced each year, which comes at significant cost to purchase as well as being a source of data entry errors as the information is collated.

This is progressively being replaced by workflow forms being migrated to tablets (think iPads), with a 5% increase in productivity being targeted across the medium term.

Investment thesis

Referring to our standard set “Themes and Structural Drivers” that we look to identify good opportunities Cleanaway provides the following access to these themes.

• Decarbonisation – an indirect benefit of the environmental focus of the economy as a whole is the contribution Cleanaway can make towards the efficiency and sustainable processing of waste.
• Companies that benefit from inflation – Cleanaway has a range of assets that it has already invested significant capital in. Inflation offers the opportunity for higher revenues in the face of relatively fixed costs, promising greater returns on current investment and higher margins.
• Technology – the options in Waste to Energy provide important upside to the current market expectations for
• Strategic assets – A critical factor in the value of the company is the difficulty of replicating the assets Cleanaway owns. This provides a barrier to entry and a range of network benefits new competitors could not replicate.
• Cheap – Unfortunately, Cleanaway is not cheap on standard metrics. It, however, is cheaper than our longstanding valuation of the company and relatively cheaper than the company has often traded at over the past 5 years.
• Growth – strong growth in line or greater than the anticipated growth in the economy as a whole.

Strategic assets – Cleanaway’s unique asset profile

While the valuation of most businesses is typically a reflection of the value of future cash flows, one might argue that Cleanaway is a little unique. Given the significant parcels of land into which it deposits its landfill, we anticipate that the value of its existing land and infrastructure assets may increase in time. Higher land values, especially those driven by improved access and scarcity, tend to see higher rates paid for waste collection and disposal.

By contrast, a typical company’s fixed assets (e.g. buildings, stock and equipment) will decline with age and will be depreciate in value.

Source: Company reports

Note: MSW = Municipal solid waste, C&D = Construction & demolition, C&I = Commercial & Industrial. Prized assets are those with and EPA licence attached.

+ Valuation appeal

CWY also looks attractive having suffered a retracement in share price.

Discount to US peers has gotten larger and the stock has fallen while bond yields increase

Source: Factset, Macquarie Research October 2023

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The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.