Thread by @DownunderValue

Cleanaway $CWY $CWY.AX is Australia’s largest waste management and recycling co. With the CEO embroiled in controversy and departing imminently, the share price has pulled back 15%. With arguably the best assets in class, is now the time to buy? Let’s take a deep dive. 👇

1. Investment thesis: A stalwart, in a growing market, with irreplaceable assets / rights, an excellent recent track record, improving valuations, and possibly a cultural turnaround starting from the top. A candidate for the buying and holding in a core portfolio.

2. Macro. Last week we discussed Amcor $AMC.AX $AMCR shifting to recyclable packaging,. Well, closing the loop requires us to look at the recycling processing side of the industry as currently 91% of plastics aren’t recycled.

https://twitter.com/DownunderValue/status/1364844919806824448

3. Megatrend. Environment and recycling is a societal (change in people’s preferences), demographic (growing population) and economic (cost savings) driven megatrend. The global recycling market is expected to grow at 5.2% CAGR this decade.

4. Geopolitical pressures. Not In My Back Yard (NIMBY) extends across international boundaries, with China in 2017 banning waste imports. Australia turned to Malaysia, Indonesia and Vietnam, but that has been problematic. Nothing like a crisis to create political momentum..

4. #AusPol. Political tailwind for waste. A senate inquiry in 2018 recommended “prioritizing the circular economy, recycling and waste to energy". The government's Modern Manufacturing Strategy ($1.5bn in 2020 budget) included waste and recycling as a priority sector.

5. Market Consolidation. Economies of scale (landfills) and network effects (collection) are driving further consolidation. Only 8% of landfills are “large” with 74% being "small", though the large sites are taking c.80% of the market share.

6. Approved Landfills are a Moat: With few new approvals for landfills, there is stiff competition for existing assets. Impending competition is limited, similar to Peter Lynch’s Gravel Pit thesis.

7. NIMBY & the West Gate Tunnel: PFAS / toxic soil from the tunnel boring is slated to partially go to CWY’s Ravenhall site, which would require approval to expand – the resultant Supreme Court Cases and #EPA backflips shows how difficult it is to get new approvals..

8. Growing Shareholder Returns. The company has grown substantially, particularly since 2016 when they improved operating efficiencies and 2018 expanded revenue / sites via acquisitions. Overall 21% diluted EPS CAGR since 2015.

9. Free Cash Flow. FCF growing strong, paving the way for debt reduction and Dividend growth (increased 10% in 1H21 to 2.25c, 2% yield on current price). Sustainable payout ratio of 59%, with long term average around 50%.

10. But is Growth Slowing? Covid-19 has been a headwind in 2019, though the most recent results 1H21 showed top-line stagnant and bottom-line growth slowing. Trend or blip?

11. Footprint 2025, a platform for continued growth. Expanding facilities; leading the industry in waste-to-energy; and also leading the industry in plastics recycling with Asahi $2502.T and Macquarie $MQG joint venture. There's a long runway ahead..

12. M&A History: CWY has been effective, expanding their footprint geographically and across new sectors. Acquired ToxFree in 2017 at 10xEV/EBITDA, and recently SKM Recycling for 2x revenue – currently loss making but potential for $10-12m EBTIDA (i.e. 5-6xEV/EBITDA).

13. M&A Activity: Veolia €VIE takeover of Suez €SEV will jointly have 14% market share and leapfrog CWY to #1 in Aus. This will likely require divestments by ACCC due to anti-trust. AFR reported today that CWY will put a bid in for Suez's assets, sparking a trading halt.

14. Incentives: Long term incentives (20-30% of salary) for management is based on a 3yr TSR, ROIC and EPS growth of min 9% EPS CAGR hurdle and 12.5% top tier threshold, with min 5.8% ROIC required. Fixed remuneration (40-55%) and short term incentives (0-25%) are v.high.

15. Insider Trading: @berthon_jones showed this graph of insider trading at CWY. Dubious when the CEO is about to be alleged for bullying in the media, and he sells right near the top. While insider selling is a bad indicator, this is a question of the outgoing CEO's culture.

16. Relative Valuation: If $BIN.AX is worth 20x EBITDA (current price) and up to 25x (projected acquisition price), and even $WM is 15x, then $CWY is arguably cheap at 13x with better portfolio of assets outside of NSW.

17. Historical Valuation: CWY is trading at PE=32, below 5yr average of 36 but higher than 2016 lows of 25. With FY21 earnings to grow from acquisitions and Covid recovery, forward PE of 25. Moreover, price to FCF is at around 10.5. Future is uncertain, but value = fair?

18. Absolute Valuation: A DCF with some conservative assumptions threw up $1.90 as fair price, which is lower than analysts who think they have a moat ($2.10) but below those who claim no moat ($1.80). It is not cheap, but again, maybe it's fair?

19. Risks: Multiple contraction; increased competition and consolidation drives margins down; loss of contracts particularly municipal waste collection; inability to expand to new landfill due to NIMBY; CEO turnover creates instability; inept board with misaligned incentives.

20. Overall, if you like utilities and think that this is the space to grow faster than slow, but slower than fast, then Cleanaway is a pretty good option. I am happy to accumulate at <$1.90 or at current price if earnings returns to 9%+ to exceed my hurdle rates.

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Questions and feedback always welcome. DYOR.

Disclaimer, I'm long CWY with a token ‘holding’ position.