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Cleanaway Banking On Better Second Half

Australia | Oct 28 2019

Cleanaway Waste is now relying on cost reductions and price increases to deliver growth in the second half of FY20, guiding to a flat first half.

-More exposed to external forces than previously expected
-Brokers cautious about any meaningful recovery in the second half
-Options for cost reductions and price increases the main hope

By Eva Brocklehurst

Cleanaway Waste Management ((CWY)) remains confident all operating segments will perform and has reiterated FY20 guidance for growth. Yet the company's first half result is now forecast to be flat, with softness driven by a combination of weak economic activity, no growth in customer volumes and weak commodity prices.

This reliance on second half growth is somewhat disconcerting, Morgans asserts, as the latest update follows the broker's positive conference briefing earlier this month. Other brokers are disappointed too, as the company should be experiencing incremental cost benefits from the acquisition of Toxfree, and the new joint venture with ResourceCo was expected to contribute as well.

UBS believes the business should be able to work through the issues but acknowledges Cleanaway Waste is a little more exposed to external forces than previously anticipated. Ultimately the broker suspects China's National Sword policy (restricting imports of solid waste as raw materials) will provide further opportunities but wants evidence that headwinds are easing before turning more positive.

Credit Suisse suspects the short timeframe between the August outlook and this downgrade means prior guidance was slightly optimistic. The broker upgrades to Neutral from Underperform on valuation grounds and reduces FY20 net profit estimates by a further -5%, having cut forecasts by -14% at the results. Credit Suisse would not be surprised if there is another downgrade to FY20 before the year is out.

The company still considers FY20 will provide improved earnings. Yet, brokers envisage any growth will probably stem from incremental synergies resulting from the Toxfree acquisition. Ord Minnett suspects the market will be sceptical about the delivery in the second half on cost saving initiatives and assertive price action, given a poor FY19 result and the weak FY20 outlook provided in August.

The broker remains cautious about a meaningful recovery in earnings in the second half but positive on the medium-term structural trends for large-scale operators in Australia's waste management industry. This view is underpinned by potential public policy and regulatory changes.

Historically, Morgans points out Cleanaway has indicated whether it is comfortable with consensus estimates. However, this year such assurance has been absent. The broker notes the company would be required to notify the market if earnings are expected to miss expectations by more than 5% and takes the opportunity to adjust assumed effective tax rates to align to recent history.

This partly offsets a downgrade to operating earnings estimates of -4-5% for FY20-22. Morgans expects operating earnings growth in FY20 of 3% and believes it too early to factor in the proposed waste-to-energy facility into forecasts.

Queensland Landfill

Macquarie was also surprised by the weakness in the first half outlook, having previously expected 8% growth. The most pertinent deviation from forecasts appears to be in Queensland landfill. The company has blamed lower local Queensland landfill volumes post the implementation of the levy.

The introduction of the Queensland landfill levy from July 1 has affected volumes, Citi notes, expecting this to impact operating earnings by up to -$10m in the first half. Credit Suisse, too, assesses Cleanaway has taken a significant hit to its pricing for landfill in Queensland, most of which will be felt in the first half.

Ord Minnett points out Cleanaway should have been able to mitigate this impost to some degree, or at the very least not be surprised by the impact, as a levy was flagged well in advance. Over the past decade, landfill levies in most markets have helped put inflation into the value chain.

Recyclables Pricing

Citi also flags the price for recycled materials has been volatile and under pressure since the China National Sword policy was implemented. The most pertinent exposure for Cleanaway is old corrugated cardboard (OCC). Citi estimates prices of OCC have halved since the first half and end markets remain under pressure.

Still, the broker highlights options resulting from cost reductions and price increases and a stabilisation in the commodity markets that could flow through from the second half. There is also Cleanaway's ability to benefit from industry consolidation, given the strength of the balance sheet.

Citi encourages investors to look through the recent volatility and focus on the quality of the balance sheet, as well as the operating leverage to be derived from price increases.

Macquarie suspects domestic economic growth reached a trough in the second quarter of 2019 and growth will recover, along with the further improvement expected in 2020, factoring in the lagged effects from easier monetary policy and the recent turnaround in real house prices.

FNArena's database has three Buy ratings and two Hold. The consensus target is $2.13, suggesting 19.2% upside to the last share price.

see also Cleanaway Waste Still On Top Of Recycling on August 19, 2019.

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