Australia | Aug 19 2019
Several brokers assert the share price of Cleanaway Waste has overshot on the downside as the company has high-quality earnings and substantial opportunities in waste management.
-Headwinds from China's National Sword policy and weak macro economy
-Value comparisons to international peers remain favourable
-Funds being retained for acquisitions and growth projects
By Eva Brocklehurst
Cleanaway Waste Management ((CWY)) attempted to soften market expectations by providing a cautious outlook with its FY19 results. However, a track record of consistently beating forecasts may have accentuated the negative share price reaction, Ord Minnett suggests.
The company took the opportunity to ease market expectations for FY20 particularly given the current market in recycling, where lower commodity prices and a lack of investment have been exacerbated by policy settings in foreign markets regarding the acceptance of contaminated recyclables.
Yet, Morgans notes, the quality of the results was high, with 100% cash conversion of operating earnings (EBITDA) and operating cash flow lifting 59%. The company expects that Toxfree acquisition synergies can also be achieved on time and on budget.
While general economic softness could be an obstacle, Ord Minnett upgrades to Accumulate from Hold, suggesting the Australian waste management industry is poised for structural change and the company remains well-positioned.
Some headwinds may persist for the near term, particularly with respect to lower volumes as the macro economy slows. Still, Cleanaway Waste has a national presence, vertical integration and significant capacity on its balance sheet and the recent sell-off is considered overdone.
Morgans also upgrades, to Add from Hold, agreeing the share price has overshot on the downside. Each business segment benefited from the acquisition of Toxfree and the company asserts that, excluding the Toxfree acquisition, organic growth of 10.7% was achieved in the second half.
UBS agrees the stock offers defensive characteristics, calculating the added benefit of Toxfree synergies will deliver incremental earnings (EBIT) growth of 7% and 2% in FY20 and FY21 respectively.
A softer economy and the issues with China National Sword are weighing but Macquarie finds an opportunity still exists, as valuation comparisons to international peers remain favourable and the stock offers a unique exposure to the Australian waste industry.
Credit Suisse is more cautious, highlighting that management refrained from reiterating margin targets, suspecting this stems from lower prices for recyclable commodities and higher sorting costs. Taking in accounting standard changes, the broker cuts FY20 estimates for earnings per share by -14%. Credit Suisse believes market conditions require a discounted valuation and incorporates a -10-15% discount to multiples, downgrading to Underperform from Neutral.
China's National Sword policy, which contains higher specifications for the purity of imported recyclable waste, has resulted in increased sorting costs and variability in pricing for recyclable commodities.
The company anticipates this will be mitigated through price increases. However, Credit Suisse suspects Cleanaway Waste is struggling to obtain these price increases because of softer economic conditions and potentially higher levels of competition.
The broker was previously of the view that the business had relatively low exposure to the travails in the broader economy, but it appears that around 10% of the commercial & industrial business is based on on-demand waste collection services rather than regular scheduled services.
Macquarie notes management's assessment of the negative impact of China National Sword appears to have swelled to -$5-6m from the -$1m originally forecast in February, pointing out that, since February, old corrugated cardboard prices have halved.
Funds For Growth
Morgans had thought Cleanaway Waste would undertake some form of capital return but management instead chose to retain funds on the balance sheet for acquisitions and growth projects. The company has indicated it will be considering the Victorian SKM recycling business which is gone into voluntary administration.
Cleanaway Waste has around $318m in headroom under its existing banking facilities and has no intention of changing its pay-out ratio, Macquarie notes, ahead of the tapering in landfill remediation cash flows which starts in FY21.
The broker anticipates a path to solid investment-led growth in recycling, alternative treatment and disposal projects. The company is integrating a healthcare bolt-on to the Daniel's sharps management solutions, which brings a plastic container manufacturing capability to the business.
The ResourceCo joint venture is also ramping up the extraction of processed engineered fuels, although this is been slowed by the ability to sell the fuel into south-east Asian markets, where waste bans affected import processes.
These issues are being resolved which should mean the JV will make a positive contribution in FY20, Macquarie suggests. ResourceCo is a global operator focused on recovering resources to manufacture recycled materials and alternative fuels.
The broker sees a substantial opportunity in the downstream processing of waste streams and considers this would be a logical addition to the company's value chain. The remediation of the Clayton landfill is on track for a step down in cash outflow going into FY21.
FNArena's database shows three Buy ratings, one Hold (UBS) and one Sell (Credit Suisse). The consensus target is $2.25, signalling 5.7% upside to the last share price. Targets range from $1.85 (Credit Suisse) to $2.60 (Macquarie).
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