Company Reports

We transfer coverage of no-moat Cleanaway and maintain our fair value estimate of AUD 2.30 per share. We have lifted revenue growth expectations for the group, but temper our margin expectations for the industrial, and liquid and health waste businesses. We still expect margin growth in these businesses, but at a slower pace, driven by operating efficiency initiatives and positive margin mix from higher-margin waste disposal earnings at landfill assets. We maintain our previous Standard Morningstar Capital Allocation Rating, Medium Morningstar Uncertainty Rating, and no-moat rating.

Cleanaway has pledged to increase capital investment for approximately 10 years through to 2030 as it completes a variety of circular economy strategies to divert waste from landfills. To date, the Eastern Creek Food and Garden Organics is the largest active project, supporting the federal government’s goal to halve waste sent to landfills by 2030. Where possible, the company seeks to monetize output from these initiatives, such as selling energy and resins recovered in processing.

No-moat Cleanaway is acquiring the Citywide Waste waste and recycling business for AUD 110 million. The deal includes a 35-year lease for the Dynon Road waste transfer station in Melbourne. Dynon Road is Victoria’s second-largest waste transfer station, with capacity for about 215,000 metric tons of waste and recycling material annually. The acquisition is subject to approval by the Australian Competition and Consumer Commission. The deal would see Cleanaway owning two of the largest transfer stations in Victoria, but with other competition remaining in the waste handling industry, we think it is likely to get a green light.

We are cautious on the upside potential of Cleanaway’s strategy, which seeks to enhance shareholder value through strategic infrastructure investments, increased customer service, and operational excellence. Cleanaway is Australia’s largest waste management business with leading positions in municipal waste, commercial and industrial waste, liquid waste (nonhazardous and hazardous), and medical waste. Unfortunately, Cleanaway was a late mover in developing and acquiring post-collection infrastructure (landfills, transfer stations, recycling facilities, waste processing plants, incinerators, and energy from waste facilities) with global players waste management competitors, such as Veolia and Suez, possessing at strategically located post-collections assets which offer cost advantages. Cleanaway can't replicate competitors' post collections footprint without significant investment. Even then, Cleanaway’s position on the of waste processing cost curve is unlikely to match competitors who have developed their infrastructure at lower capital cost.

We are encouraged by no-moat Cleanaway’s plan to reduce capital expenditure by AUD 50 million a year from fiscal 2025. This includes outsourcing ownership of its heavy vehicle fleet, using digital and analytics in fleet pooling decision-making, and hiring specialized project management teams to improve capital efficiency.

Profit has improved materially at no-moat-rated Cleanaway. First-half fiscal 2024 underlying EBIT grew 26% to AUD 174 million versus the previous corresponding period to meet our expectations. New business and price increases were tailwinds. The EBIT margin also improved to 11%, up 160 basis points on the PCP. This reflects efficiency and operating cost improvements, such using data and analytics to optimize truck routes, and workforce management.

We are cautious on the upside potential of Cleanaway’s strategy, which seeks to enhance shareholder value through strategic infrastructure investments, increased customer service, and operational excellence. Cleanaway is Australia’s largest waste management business with leading positions in municipal waste, commercial and industrial waste, liquid waste (nonhazardous and hazardous), and medical waste. Unfortunately, Cleanaway was a late mover in developing and acquiring post-collection infrastructure (landfills, transfer stations, recycling facilities, waste processing plants, incinerators, and energy from waste facilities) with global players waste management competitors, such as Veolia and Suez, possessing at strategically located post-collections assets which offer cost advantages. Cleanaway can't replicate competitors' post collections footprint without significant investment. Even then, Cleanaway’s position on the of waste processing cost curve is unlikely to match competitors who have developed their infrastructure at lower capital cost.

We are cautious on the upside potential of Cleanaway’s strategy, which seeks to enhance shareholder value through strategic infrastructure investments, increased customer service, and operational excellence. Cleanaway is Australia’s largest waste management business with leading positions in municipal waste, commercial and industrial waste, liquid waste (nonhazardous and hazardous), and medical waste. Unfortunately, Cleanaway was a late mover in developing and acquiring post-collection infrastructure (landfills, transfer stations, recycling facilities, waste processing plants, incinerators, and energy from waste facilities) with global players waste management competitors, such as Veolia and Suez, possessing at strategically located post-collections assets which offer cost advantages. Cleanaway can't replicate competitors' post collections footprint without significant investment. Even then, Cleanaway’s position on the of waste processing cost curve is unlikely to match competitors who have developed their infrastructure at lower capital cost.

We maintain our AUD 2.20 fair value estimate for no-moat Cleanaway. Management guided to fiscal 2024 EBIT of roughly AUD 350 million, implying 16% earnings growth in fiscal 2023. While strong, the benefits of Cleanaway’s recent price increases and its costs easing overall are likely being hindered by inflationary pressures more than we expected. We decrease our fiscal 2024 EBIT forecast by 4% to AUD 358 million. However, we leave our long-term earnings estimates unchanged, including our fiscal 2026 EBIT forecast of AUD 451 million, with management reiterating its fiscal 2026 EBIT target of at least AUD 450 million. With conditions stabilizing and lower disposal and fleet costs, the firm remains focused on efficiency and productivity improvements at its sites.

No-moat Cleanaway’s investor day focused on strategic infrastructure growth, the first of three pillars to the group's BluePrint 2030 strategy. While we endorse Cleanaway’s execution plans, we make no changes to our AUD 2.10 fair value estimate. We believe Cleanaway is well placed in the current environment owing to: earnings resilience to business cycles; the group’s ability to pass-through inflation driven increases in labour and fuel costs to customers; strong ESG-attributes in the post collection business; and future earnings growth contribution from the recently-acquired Suez assets. However, we believe these positive dynamics are more than reflected in the current share price, which currently trades at a 39% premium to our fair value estimate.

We lower our full-year EBITDA forecast for no-moat Cleanaway by 3% to AUD 575 million. This is in response to Cleanaway's revised fiscal 2022 guidance that implies a decrease in expected full-year EBITDA by around AUD 15 million-AUD 20 million on the previously disclosed outlook. The revision largely relates to a range of cost headwinds, which we have incorporated within our forecast.

With the Australian economy staging a robust recovery from the coronavirus shock, Cleanaway’s newly announced CEO, Mark Schubert, is set to take the reins at an opportune time. We’d previously anticipated a sombre recovery in Cleanaway’s waste volumes would take hold in fiscal 2022, following a fiscal 2021 where waste generation has been hampered by the pandemic. However, with the Australian economy’s performance in recent quarters outpacing our prior expectations, a marked recovery in waste generation is likely underway economy-wide.

We make no change to our AUD 1.95 per share fair value estimate for no-moat Cleanaway, having already incorporated the previously mooted acquisition of key Australian waste disposal assets from no-moat Suez into our financial estimates. As anticipated, Suez has consented to its acquisition by no-moat Veolia—agreeing to a price of EUR 20.50 per Suez share. As a result, Cleanaway’s proposed acquisition of Suez’s Australian operations in their entirety won’t proceed. Rather, the acquisition of key post-collection assets from Suez—including the prized Lucas Heights landfill located in Sydney’s south—will go ahead. With the deal anticipated to close in the second quarter of calendar year 2022, we factor earnings from the post-collection assets from fiscal 2023 onward.

We view the proposed acquisition by Cleanaway of no-moat Suez’s entire Australian waste management as unlikely. The mooted AUD 2.52 billion transaction is contingent on the failure of no-moat Veolia’s ongoing tender offer for Suez. But with the Veolia-Suez tie-up expected to proceed, it is improbable that Cleanaway will acquire Suez’s Australian operations in their entirety. Nonetheless, an attractive consolation prize exists for Cleanaway involving the purchase of a number of key metropolitan Sydney post-collection waste management assets. Cleanaway will pay AUD 501 million for the post-collection assets earmarked by Suez. With this ‘consolation’ deal expected to proceed--and shareholder value accretive given the deal's modest price tag--we raise our fair value estimate by 8% to AUD 1.95 per share. Shares in the no-moat name screen expensively, trading at a 31% premium to our revised valuation.

News of the imminent departure of Cleanaway’s CEO, Vik Bansal, surprised the market but has no impact on our financial estimates for the no-moat name. Equally, Bansal’s impending exit has no bearing on our valuation of Cleanaway. Nonetheless, a time-value-of-money adjustment leads us to lift our fair value estimate for Australia’s largest waste manager by 2% to AUD 1.80 per share. Cleanaway’s shares responded vigorously to the news that Bansal will vacate the top job in the first half of calendar year 2021 with shares down 8% in early trade. Bansal’s past transgressions--which consist of a history of reportedly combative leadership and an ill-timed sale of approximately 43% of his personal stake in the company--evidently brought him undone. Revelations of Bansal’s questionable managerial conduct first came to light in the financial press in September 2020--for greater detail please see our note “Cleanaway’s Subdued First Quarter 2021 Matches Our Expectations but Shares Remain Pricey” dated Oct.14, 2020.

We are positive on Cleanaway’s strategy, which seeks to maintain its leading position in commercial and industrial, or C&I, and municipal waste collections and to continue to improve its moat profile by investing in midstream materials recovery assets and, where possible, in downstream disposal assets. Cleanaway’s is the leading player in C&I and municipal waste with about 140,000 C&I customers and some 90 municipal council waste collection contracts. The economics of the waste management industry are overwhelmingly local in nature. Cleanaway’s strong presence in all of Australia’s state capital cities is aimed at local market dominance. This local market dominance in turn delivers route density that spreads the fixed costs--an imperative for profit generation in waste collection.

We make no change to our AUD 1.75 per share fair value estimate or earnings forecasts for Cleanaway Waste Management following its first-quarter fiscal 2021 trading update. Cleanaway asserts that trading conditions in the first three months of fiscal 2021 have been mixed with EBITDA largely flat relative to fiscal 2020’s full-year run-rate. Its Victorian waste management businesses have been most impacted given Stage 4 coronavirus lockdown settings implemented in early August 2020 remain in place. As restrictions likely ease in Victoria, and economic activity recovers more broadly within the Australian economy, Cleanaway expects moderate EBITDA growth in fiscal 2021, aligning with our unchanged fiscal 2021 EBITDA forecast of AUD 528 million. Despite recent underperformance of Cleanaway’s share price following revelations in mainstream media regarding the managerial conduct of CEO Vik Bansal, the no-moat name remains expensive.

Our AUD 1.70 per share fair value estimate for Cleanaway remains intact, with the advent of the COVID-19 pandemic having no bearing on our long-term expectations for the no-moat name. We expect Cleanaway Waste Management’s earnings to exhibit relative resilience to both the immediate and medium-term impacts of COVID-19. Understandably, the operations of Cleanaway Waste Management--as Australia’s largest integrated waste management business--have been deemed an essential service by Australian federal and state governments. As such, present COVID-19 containment measures will not interrupt Cleanaway’s operations. Relatedly, we make no changes to our fiscal 2020 earnings estimates, despite the recent withdrawal of prior fiscal 2020 earnings guidance.

No-moat Cleanaway showed greater resilience to softening Australian economic conditions in first-half fiscal 2020 than we’d anticipated. Earnings grew in spite of management’s warning in October 2019 of a soft start to fiscal 2020 that would likely result in flat first-half EBITDA. The solid waste segment--Cleanaway’s largest at 70% of operating income excluding corporate overheads--posted a strong underlying result with growth in organic volumes achieved despite concerns of economic malaise. With solid waste volumes less challenged in the current environment than we’d previously anticipated, we’ve upgraded our full-year fiscal 2020 EBITDA forecast by a minor 0.5% to AUD 479 million. Our revised forecast sits toward the top end of Cleanaway’s full-year fiscal 2020 EBITDA guidance range of AUD 471 million-AUD 481 million, excluding the earnings benefit from changes in IFRS accounting standards for operating leases. However, we continue to expect a five-year EBIT CAGR of 12%, leading us to retain our AUD 1.70 per share fair value estimate. While we continue to expect strong growth in operating earnings, we regard Cleanaway shares as overvalued.

Despite a weak start to fiscal 2020, our long-term expectations for no-moat Cleanaway are unchanged. Our AUD 1.70 per share valuation is also unchanged following today’s trading update which highlighted soft year-to-date volumes in fiscal 2020. We now forecast flat waste volumes for Cleanaway in fiscal 2020, down from prior expectations for growth of 1.4%, before volume growth rebounds to 1.4% in fiscal 2021. Accordingly, we’ve reduced our full-year fiscal 2020 EBIT forecast by 4% to AUD 251 million, reflecting moderated volume assumptions in this fiscal year. Nonetheless, our longer-term expectations for Australian waste volumes remain unchanged, with population growth and increased per capita waste generation rates to drive waste volumes higher. We expect waste volumes to grow at an unchanged average 1.2% annually over the fiscal 2021--fiscal 2029 period. Therefore, we continue to expect robust medium-term earnings growth, owing to substantial operating leverage, the delivery of further synergies from the Toxfree acquisition and a resumption of modest growth in Australian waste volumes in fiscal 2021 onward. Our five-year EBIT CAGR estimate of 8.7% is largely unchanged. Investors sent Cleanaway shares sharply lower following the trading update. While shares now appear less rich--last trading at an 8% premium to our fair value estimate--margin of safety remains absent at current share price levels. We recommend awaiting further weakness before considering a position in the name.