Cleanaway Waste Management - Morgans

Environmental│Australia│Equity research│February 21, 2018

Cleanaway Waste Management Ready to pick up

ADD (previously HOLD) Current price: Target price: Previous target: Up/downside: Reuters: Bloomberg: Market cap:

A$1.52 A$1.68 A$1.61 10.6% CWY.AX CWY AU US$2,424m A$3,091m US$7.27m A$9.30m 2,034m 100.0%

Average daily turnover: Current shares o/s Free float:

Price Close

Relative to S&P/ASX 200 (RHS)

■ The 1H18 result showed solid business growth and was ahead of our forecast. ■ Our DCF-based 12 month target price has lifted 7 cps to $1.68, as a result of uplift to forecasts (partly offset by higher net debt) and six month valuation roll-forward.

■ We upgrade to an ADD, given ~11% potential upside at current prices.

1H18 result summary EBITDA increased 5.7% on pcp to $159m, with net revenue growth of +7.4% offset by 40bps decline in group margin; the result beat our forecast of $157m. EBITDA growth was stronger (+7.6%) if a $2.9m write-off of bad debts is removed from Corporate costs. Earnings outperformance against our forecast came from both Solids revenue growth (albeit management is disappointed in the Collections performance) and sustained margin improvement within Liquids and Industrial Services (hydrocarbons was acknowledged as the best performer in the division). EBIT increased 18.7%, benefitting from lower D&A due to the partial closure of the Clayton landfills. EPS rose by 23.8% on pcp. Operating CF increased 13%, but was 8% below our forecast due to a marked increase in tax paid (top-up payment and PAYG instalments). Landfill remediation continues to be a drag on Operating CF ($20m in 1H18 vs a budget of ~$45m pa across FY18-20, $20m pa across FY21-25, and $10m pa thereafter). Another closed landfill site was sold, reducing remediation exposure by $5m. Capital spend included $93m capex (117% of D&A), $19m investments, and $31m finance leases.

1.600

134.6

1.400

121.7

Earnings outlook

1.200

108.9

1.000 40

96.0

We have lifted our EBITDA forecast across FY18-21F by 1-2%, after reflecting the profitability evident in 1H18. Management remains comfortable with market consensus expectations for FY18 EBITDA of $319-320m. However, we think this is conservative – it is effectively annualising 1H18 without any allowance for ramp-up in new contracts in 2H18; we target $323m EBITDA. As well as underlying organic growth, recent major contract wins should establish a firm base for revenue growth in Solids in 2H18/FY19. The NSW Container Deposit Scheme started in Dec-17, Coles commenced Oct-17, the Central Coast municipal contract (Australia’s second largest muni contract) commences Feb-18, and the Brisbane City Council resource recovery contract (albeit lower margin / lower capital intensity) starts Jul-18. Possibly we are too bullish with our margin expectations given customer quality and the activities undertaken, but we also expect scale benefits to be realised. CWY is increasingly optimistic of achieving medium-longterm growth from Liquids & Industrial Services, particularly when combined with the TOX acquisition (completion still expected by end-FY18). TOX (1H earnings were in-line but cash was below CWY’s expectations) will drive more EBITDA growth in FY19, with $35m pa synergies within two years further lifting the contribution. Thus, we target 15% EBITDA and 18% EPS CAGR across FY19-22. However, invested capital increases by ~47% in FY18 from funding the growth.

30

Vol m

20 10 Feb-17

May-17

Aug-17

Nov-17

Source: Bloomberg

Price performance Absolute (%) Relative (%)

1M 4.8 5.8

Nathan LEAD T (61) 7 3334 4548 E [email protected]

3M -0.3 0

12M 34.5 31.9

Other interesting items CWY intends to utilise $95m of finance leases in FY18 for the kit required to service the BCC, CDS and new municipal contracts. In addition, FY18 cash capex is expected to be 80-85% of a D&A expense of $165-170m (includes construction of Erskine Park transfer station target for completion 1H19). CWY sees recent changes to the Chinese importation of municipal recycled waste as an opportunity by assisting local governments mitigate the issue. Financial Summary Revenue (A$m) Operating EBITDA (A$m) Net Profit (A$m) Normalised EPS (A$) Normalised EPS Growth FD Normalised P/E (x) DPS (A$) Dividend Yield EV/EBITDA (x) P/FCFE (x) Net Gearing P/BV (x) ROE % Change In Normalised EPS Estimates Normalised EPS/consensus EPS (x)

Jun-15A 1,385 229.9 (23.6) 0.029 (95.3%) 52.54 0.015 0.99% 11.79 16.9 17.9% 1.37 2.58%

Jun-16A 1,455 280.0 44.8 0.040 38.2% 38.01 0.017 1.12% 9.69 73.1 17.5% 1.36 3.60%

Jun-17A 1,454 300.1 72.5 0.049 21.9% 31.17 0.021 1.38% 9.10 126.5 17.9% 1.33 4.31%

Jun-18F 1,570 321.9 51.7 0.053 8.1% 28.83 0.021 1.38% 10.74 NA 29.5% 1.27 4.50% 11.0% 1.01

Jun-19F 2,189 458.8 132.2 0.068 29.8% 22.20 0.035 2.30% 8.22 61.0 27.8% 1.24 5.65% (2.0%) 1.07

SOURCE: MORGANS, COMPANY REPORTS IMPORTANT DISCLOSURES REGARDING COMPANIES THAT ARE THE SUBJECT OF THIS REPORT AND AN EXPLANATION OF RECOMMENDATIONS CAN BE FOUND AT THE END OF THIS DOCUMENT. MORGANS FINANCIAL LIMITED (ABN 49 010 669 726) AFSL 235410 - A PARTICIPANT OF ASX GROUP

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Figure 1: Financial summary Valuation Enterprise value (DCF) Net debt Equity value ($m) Shares on issue (million) Equity value per share ($) Profit and loss ($m) Solids Liquids & Industrial Services Corporate and eliminations Revenue - growth Solids Liquids & Industrial Services Corporate and Other Associates EBITDA - growth - margin D&A EBIT - growth Cash net interest expense Non cash interest expense Underlying tax Underlying NPAT - growth Material items post-tax NPAT Minorities SPS distribution NPAT to shareholders - growth EPS (normalised) (cps) - growth Dividends (cps) - growth - payout Cashflow statement ($m) EBITDA excl. associates Wcap, landfill remediation spend, one-offs Gross operating cashflow Net interest paid Tax paid Operating cashflow

Jun-15A 967 476 (58) 1,385 -26.7% 198 56 (24) 1 231 -80% 16.7% (134) 98 -91% (13) (15) (16) 54 -95% (69) (15) (1) (8) (24) -305% 2.9 -95% 1.5 52%

Jun-16A 1,090 437 (72) 1,455 5.1% 238 58 (15) 1 281 22% 19.3% (159) 123 26% (19) (15) (27) 62 14% (19) 43 2 45 -290%

Jun-17A 1,099 424 (69) 1,454 -0.0% 257 59 (16) 1 301 7% 20.7% (158) 143 17% (18) (15) (32) 78 26% (5) 73 73 62%

4.0 38% 1.7 13% 43%

4.9 22% 2.1 24% 43%

Jun-18 4,013 (720) 3,293 2,034 $1.62

Jun-19 4,227 (699) 3,529 2,034 $1.74

Jun-20 4,421 (659) 3,762 2,034 $1.85

Jun-21 4,567 (570) 3,997 2,034 $1.97

Jun-22 4,716 (480) 4,237 2,034 $2.08

Jun-18E 1,219 432 (81) 1,570 7.9% 280 60 (19) 1 323 7% 20.6% (165) 158 10% (7) (15) (40) 96 23% (44) 52 52 -29%

Jun-19E 1,507 789 (107) 2,189 39.4% 356 119 (16) 1 460 42% 21.0% (217) 243 54% (32) (14) (57) 139 46% (7) 132 132 156%

Jun-20E 1,540 821 (109) 2,252 2.9% 373 142 (17) 1 500 9% 22.2% (219) 281 16% (33) (14) (68) 166 19% (18) 149 149 13%

Jun-21E 1,573 848 (112) 2,310 2.6% 394 159 (17) 1 538 8% 23.3% (221) 317 13% (31) (14) (79) 193 16% 193 193 30%

Jun-22E 1,608 879 (115) 2,373 2.7% 411 169 (17) 1 564 5% 23.8% (223) 341 8% (29) (14) (86) 212 10% 212 212 10%

5.3 8% 2.1 40%

6.8 30% 3.5 67% 51%

8.2 19% 4.1 17% 50%

9.5 16% 4.8 17% 51%

10.4 10% 5.2 8% 50%

Jun-15A 230 (34) 196 (10) (9) 178

Jun-16A 280 (73) 207 (21) 7 193

Jun-17A 300 (81) 219 (20) (9) 190

Jun-18E 322 (106) 216 (8) (32) 177

Jun-19E 459 (86) 373 (32) (42) 299

Jun-20E 499 (69) 430 (33) (54) 343

Jun-21E 537 (26) 511 (31) (70) 410

Jun-22E 563 (24) 539 (29) (83) 427

Capex Acquisitions/disposals Investing cashflow - % of revenue Free cashflow

(176) (148) (324) 23% (146)

(154) (12) (165) 11% 28

(155) (29) (185) 13% 6

(229) (675) (904) 58% (728)

(197) (21) (218) 10% 80

(203) (21) (224) 10% 119

(208) (21) (229) 10% 181

(213) (21) (234) 10% 192

Equity issuance/(returns) Debt drawdown/(repaid) Dividends paid OtherFinancingCashflow Financing cashflow

289 (42) (253) (7)

4 5 (25) (1) (17)

7 13 (30) (1) (11)

593 187 (39) (12) 729

(29) (57) (2) (88)

(40) (77) (2) (119)

(16) (89) (3) (109)

(16) (102) (118)

Net cashflow

(154)

11

(5)

(8)

(0)

72

75

Jun-20E 36 383 1,274 2,185 136 4,015 691 269 482 1,442 2,573

Jun-21E 109 393 1,304 2,164 136 4,105 674 272 483 1,429 2,676

Jun-22E 183 404 1,337 2,141 137 4,203 661 278 477 1,416 2,786

1.3x

1.1x

0.9x

Balance sheet ($m) Cash Debtors Fixed Assets Intangibles Other Total Assets Debt Creditors Other liabilities Total Liabilities Net Assets Net Debt / EBITDA (x)

1

Jun-15A 37 227 860 1,536 209 2,870 352 179 585 1,115 1,755

Jun-16A 48 224 897 1,568 172 2,910 359 179 590 1,128 1,782

Jun-17A 43 248 937 1,585 145 2,958 370 178 585 1,133 1,825

Jun-18E 44 266 1,229 2,224 146 3,910 761 190 533 1,484 2,426

Jun-19E 36 372 1,249 2,205 143 4,006 731 265 508 1,505 2,501

1.3x

1.1x

1.1x

2.2x

1.5x

SOURCE: MORGANS RESEARCH, COMPANY

2


1H18 result summary The table below summarises the 1H18 result and compares it to previous periods and our forecast. Figure 2: 1H18 result summary 1H17

2H17

1H18A r pcp

1H18F

% diff Comments on 1H18

$m $m $m $m $m $m $m $m $m $m

404 146 (18) 532 208 0 (15) 725 (52) 672

407 143 (19) 531 216 (17) 730 (52) 678

442 171 (25) 588 215 0 (17) 786 (63) 722

3% 11% 32% 5% -0%

11% 8% 21% 7.4%

428 154 (19) 562 216 0 (16) 762 (55) 707

5% 3% 15% 2%

Solid organic growth assisted by small bolt-on acquisitions

Opex excl. landfill levies

$m

(522)

(527)

(563)

8%

(550)

2%

Ramp-up and mobilisation of major new contracts in progress.

Solids - Collections - margin Solids - Post-Collections - margin Solids - Total EBITDA - margin Liquids & Industrials - margin Corporate and Other Associates Group EBITDA - margin

$m % $m % $m % $m % $m $m $m %

81 20.0% 48 51.0% 129 26.8% 29 13.8% (8) 0 150 22.4%

80 19.7% 48 53.0% 128 26.8% 30 13.9% (8) 1 151 22.2%

85 19.3% 54 50.0% 139 26.6% 30 14.0% (10) 0 159 22.0%

5% -0.7% 13% -2.0% 8% -1.1% 4% 0.9% 39% -50% 6% -0.4%

83 19.7% 52 53.0% 135 26.7% 29 13.5% (8) 0 157 22.2%

3% -0.3% 3% -3% 3% -0.1% 3% 1% 36% -51% 1% -0.2%

D&A Underlying EBIT - margin

$m $m %

(83) 67 9.2%

(75) 76 10.4%

(79) 80 10.1%

-5% 19% 0.9%

(79) 78 10.2%

0% 2% -0.1%

Variable as CWY enters final phase of closure of all Clayton landfills in 2018

Net finance costs Tax Material items post-tax NPAT

$m $m $m $m

(17) (15) (7) 28

(17) (17) 2 45

(17) (19) 1 45

-2% 26% -116% 61%

(17) (18) (2) 41

-3% 7% -152% 10%

Expect $4m pa interest cost savings from expiry of USPP in Dec-17

Cashflows: Operating CF Investing CF Free CF

$m $m $m

100 (103) (3)

90 (81) 9

113 (109) 4

13% 6% -219%

122 (127) (5)

-8% Strong cash conversion. $20m increase in tax. Remediation $20m. -14% $93m capex (117% D&A) + $19 investments. $31m finance lease not in CF. -169%

Capital management: Net debt Net debt:EBITDA

$m x

315 1.1x

320 1.1x

(142) -0.5x

-145% -1.5x

343 1.1x

-141% -1.6x

Dividend per share

cps

1.0c

1.1c

1.1c

10%

1.0c

10%

Item Earnings: Solids - Collections Solids - Post-Collections Solids - Intracompany Solids - total revenue Liquids & Industrials Corporate Intracompany elimination Statutory revenue Landfill levies Ext. revenue exc. levies

units

9% 18% 40% 11% 3%

Volume and price increases. +$5.4m from SA Waste bolt-on acquired 3/7/17 Increased East Coast activity. New Melbourne transfer station fully operational.

Early signs of sustained improvement. Positive re: medium-long term growth

New Melbourne transfer station Relatively stable margins at the Solids divisional level Focus growth in the infrastructure and resources leading to improve work pipeline Further restructuring increased cost efficiencies We believe $2.9m related to write-off of bad debts. Normalising aligns with pcp. 7.6% growth on pcp after normalising for write-off of bad debts Stable margins after normalising for bad debts write-off

This excludes drawn debt for bank guarantees. $31m of new finance leases. Gearing and debt artificially low due to cap raising proceeds prior to TOX acq. 1H18: Fully franked. 51% payout of underlying profit in 1H18. DRP in operation. SOURCE: MORGANS RESEARCH, COMPANY

3


Other interesting items 

CWY strategy continues to be underpinned by 5 key pillars.

Figure 3: Sum-of-the-parts valuation

SOURCE: CWY



CWY says the recent Chinese restriction on imported municipal recycled products (container levels of recycled products reduced from 5% to 0.5%) does not materially impact it, but it may provide a strategic opportunity in helping local governments mitigate the issue as most of its facilities operate at a much lower contaminant level than recyclers exporting to China.

Figure 4: Commodity revenue by percentage

SOURCE: CWY



CWY completed the $12.1m bolt-on acquisition of SA Waste on 3 July 2017. SA Waste is a waste collection and resource recovery business based in Adelaide. In 1H18, it contributed $5.4m of revenue and a $0.1m loss to PBT, after amortisation of customer intangibles of $0.7m.



CWY has further small to medium sized acquisitions identified, although the TOX integration post-completion remains the 12-18 month priority.



NSW container deposit scheme commenced on 1 December 2017. CWY acknowledged there had been issues along the way but currently there are 400 collection points across NSW. 100 million recycled containers have so far been collected. Quality of recycled material is considered to be of a high standard. The revenue upside here is potentially large, with estimates that 4


NSW generates 3.5bn containers per year and each container earns 10 cps, of which CWY earns a margin but the market is shared with competing material recycling facilities. 

CWY made no change to its landfill rectification and remediation budget of ~$45m pa across FY18-20, then ~$20m pa across FY21-25, reducing to $10m pa thereafter.

Figure 5: Landfill rectification and remediation budget

SOURCE: CWY

Forecast changes Our forecast changes reflect 1H18 forecast outperformance and management outlook indications. Figure 6: Forecast changes Item

units

FY17 actual

Old

FY18F New

r

Old

FY19F New

r

old

FY20F New

r

old

FY21F New

r

Earnings: Solids - Collections Solids - Post-Collections Liquids & Industrial Serv Corporate & Intracompany Revenue

$m $m $m $m $m

811 289 424 (69) 1,454

858 304 433 (72) 1,523

886 333 432 (81) 1,570

3% 9% -0% 12% 3%

1,107 362 791 (98) 2,162

1,138 369 789 (107) 2,189

3% 2% -0% 9% 1%

1,133 368 823 (100) 2,224

1,164 376 821 (109) 2,252

3% 2% -0% 9% 1%

1,159 375 850 (103) 2,281

1,191 383 848 (112) 2,310

3% 2% -0% 9% 1%

Opex

$m

(1,153)

(1,204)

(1,247)

4%

(1,708)

(1,729)

1%

(1,733)

(1,752)

1%

(1,754)

(1,772)

1%

EBITDA: Solids - Collections Solids - Post-Collections Solids - Total Liquids & Industrial Serv Corporate & Other Associates

$m $m $m $m $m $m $m

301 161 96 257 59 (16) 1

319 173 101 274 60 (16) 1

323 175 105 280 60 (19) 1

1% 1% 4% 2% 1% 17% -17%

454 234 115 349 120 (16) 1

460 240 115 356 119 (16) 1

1% 3% 0% 2% -1% -1% -17%

492 246 117 364 143 (17) 1

500 255 118 373 142 (17) 1

2% 4% 0% 2% -1% -1% -17%

527 263 119 383 160 (17) 1

538 275 120 394 159 (17) 1

2% 4% 0% 3% -1% -1% -17%

D&A Underlying EBIT - margin

$m $m %

(158) 143 9.8%

(165) 154 10.1%

(165) 158 10.1%

2% -0.1%

(208) 246 11.4%

(217) 243 11.1%

4% -1% -0.3%

(210) 282 12.7%

(219) 281 12.5%

4% -0% -0.2%

(212) 315 13.8%

(221) 317 13.7%

4% 1% -0.1%

Material items post-tax Net finance costs Tax NPAT underlying NPAT

$m $m $m $m $m

(5) (34) (32) 73 78

(47) (33) (35) 39 86

(44) (22) (40) 52 96

-32% 14% 33% 11%

(7) (46) (58) 135 142

(7) (47) (57) 132 139

1% -2% -2% -2%

(18) (44) (69) 151 169

(18) (47) (68) 149 166

5% -1% -2% -1%

(42) (79) 194 194

(45) (79) 193 193

7% -0% -0% -0%

Wgt Avg Shares Normalised EPS

mn cps

1,590 4.9

1,812 4.7

1,813 5.3

0% 11%

2,030 7.0

2,034 6.8

0% -2%

2,030 8.3

2,034 8.2

0% -2%

2,030 9.5

2,034 9.5

0% -1%

Dividend - payout ratio

cps %

2.1 43%

2.1 44%

2.1 40%

-4%

3.5 50%

3.5 51%

1%

4.1 49%

4.1 50%

1%

4.8 50%

4.8 51%

0%

Cashflows: Operating CF Investing CF Free CF

$m $m $m

190 (185) 6

179 (904) (725)

177 (904) (728)

-1% 0% 0%

306 (217) 89

299 (218) 80

-3% 1% -10%

339 (223) 116

343 (224) 119

1% 1% 2%

408 (228) 181

410 (229) 181

0% 1% 0%

Debt: Net debt Net debt:EBITDA

$m x

320 1.1

670 2.1

720 2.2

7% 0.1

642 1.4

699 1.5

9% 0.1

604 1.2

659 1.3

9% 0.1

516 1.0

570 1.1

11% 0.1

SOURCE: MORGANS RESEARCH, COMPANY

5


Valuation and risks Our 12 month DCF-based price target has increased 7 cps to $1.68, as a result of our forecast changes and six month valuation roll-forward to December 2018. Our valuation is based on forecast ungeared cashflows and a terminal value in 2022. We apply a 7.9% pa post-tax WACC (includes 9.0% pa cost of equity) and our terminal value implies an 8x EV/EBITDA and 13x EV/EBIT. Key risk factors that we believe may have an impact on the share price include: 

Risks related to the TOX acquisition including completion, integration, and achievement of synergies.



Ongoing business risks including economic conditions, activity in the waste management sector, regulatory risk, asset life, competition, M&A, and capital management.

A summary of the earnings outlook and trading multiples of domestic and international peers is summarised in the table below. Figure 7: Peer comparison Company

Location

Cleanaway

Australia

Price (l/currency) 1.52

Waste Management Republic Services Waste Connections Clean Harbours Advanced Disposal Biffa Plc Bingo Industries Tox Free Solutions Seche Environment Median

USA USA USA USA USA UK Australia Australia France

84.87 64.86 70.47 52.50 23.61 2.31 2.59 3.43 29.60

Mcap EV:EBITDA Est. EBITDA EV:EBIT Est. EBIT PER Yield Net debt:EBITDA (mn) (next 12m) grwth (next 2yrs) (next 12m) grwth (next 2yrs) (next 12m) (next 12m) (next 12m) 3,091 9.6 24% 18.7 30% 24.7 1.8% 1.8 46,593 27,195 23,472 3,784 2,643 1,039 1,010 669 367

10.7 10.2 13.5 8.3 8.8 5.4 11.4 9.3 6.1 9.3

5% 5% 7% 9% 4% 7% n/a 4% 7% 6%

16.2 16.7 24.0 22.0 26.9 9.9 14.8 18.4 15.3 16.7

6% 6% 24% 31% 4% 8% n/a 5% 8% 7%

20.8 20.8 27.7 47.4 39.4 11.3 18.6 24.1 12.8 20.8

2.1% 2.2% 0.8% 0.0% 0.0% 3.1% 2.6% 2.8% 3.3% 2.2%

2.0 2.8 1.8 2.1 4.1 1.8 1.4 1.7 3.8 2.0

SOURCE:FACTSET, MORGANS RESEARCH

6


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Disclaimer The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual’s relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so. Those acting upon such information without advice do so entirely at their own risk. This report was prepared as private communication to clients of Morgans and is not intended for public circulation, publication or for use by any third party. The contents of this report may not be reproduced in whole or in part without the prior written consent of Morgans. While this report is based on information from sources which Morgans believes are reliable, its accuracy and completeness cannot be guaranteed. Any opinions expressed reflect Morgans judgement at this date and are subject to change. Morgans is under no obligation to provide revised assessments in the event of changed circumstances. This report does not constitute an offer or invitation to purchase any securities and should not be relied upon in connection with any contract or commitment whatsoever.

Disclosure of interest Morgans may from time to time hold an interest in any security referred to in this report and may, as principal or agent, sell such interests. Morgans may previously have acted as manager or co-manager of a public offering of any such securities. Morgans affiliates may provide or have provided banking services or corporate finance to the companies referred to in the report. The knowledge of affiliates concerning such services may not be reflected in this report. Morgans advises that it may earn brokerage, commissions, fees or other benefits and advantages, direct or indirect, in connection with the making of a recommendation or a dealing by a client in these securities. Some or all of Morgans Authorised Representatives may be remunerated wholly or partly by way of commission.

Regulatory disclosures Analyst owns shares in the following mentioned company(ies): -

Recommendation structure For a full explanation of the recommendation structure, refer to our website at http://www.morgans.com.au/research_disclaimer

Research team For analyst qualifications and experience, refer to our website at http://www.morgans.com.au/research-and-markets/our-research-team

Stocks under coverage For a full list of stocks under coverage, refer to our website at http://www.morgans.com.au/research-and-markets/company-analysis/ASX100-Companies-under-coverage and http://www.morgans.com.au/research-and-markets/company-analysis/EX-100-Companies-under-coverage

Stock selection process For an overview on the stock selection process, refer to our website at http://www.morgans.com.au/research-and-markets/company-analysis

www.morgans.com.au If you no longer wish to receive Morgans publications please contact your local Morgans branch or write to GPO Box 202 Brisbane QLD 4001 and include your account details. 12.12.17

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