|Shares Out. (in M):||303||P/E||33.4||14.7|
|Market Cap (in $M):||621||P/FCF||33.4||14.7|
|Net Debt (in $M):||200||EBIT||38||67|
|TEV (in $M):||821||TEV/EBIT||20.9||12|
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Biffa is a leading, vertically-integrated waste management company in the UK, with March FY 2020 revenues and EBITDA of £1.1 bb and £155 mm, respectively. Biffa has a well-balanced presence across both the collection and disposal sides of the business, including an industry leading Industrial & Commercial (I&C) collections business, municipal collections (residential), transfer stations, landfills, recycling infrastructure and interests in electricity from waste (EfW) plants that are in the process of being constructed. This posting serves as an update to ad17’s excellent writeup dated Feb 4, 2019. For more detailed background on the business and the industry, please refer to that writeup.
Brief Segment Descriptions
Industrial & Commercial (I&C): provides a wide range of services to corporate, industrial, commercial and public sector customers, including waste collection, sorting services for the recovery of recyclable material and transfer of residual waste, and processing and organizing waste materials for energy recovery as refuse-derived fuel. The mix is roughly 55% SMEs and 45% larger corporates. Industry exposures cover the full gamut of the UK economy, including all aspects of retail, leisure, office buildings, education, utilities, etc. Notably they have very little exposure to construction, which is deemed the most volatile type of customer within I&C.
Municipal: predominantly offers household waste and recycling collection services to waste collection authority customers across the UK, as well as various associated waste management services, including street cleaning, management of household waste and recycling centers and green waste collection services from individual household customers.
Resource Recovery & Treatment (RR&T): focuses on the treatment, recycling and disposal of waste, including hazardous waste materials. RR&T’s operational assets include 8 active landfill sites, two materials recycling facilities (sorting operations), a high-density polyethylene (HDPE) and PET plastics recycling business, soil treatment and composting facilities, and a hazardous waste collection and treatment network.
Energy: comprises the Company’s energy production operations from landfill gas and from food waste via anaerobic digestion. The largest unit in the division is the network of landfill gas operations, in place at 33 landfill sites across the UK, which utilize 94 electricity generators to produce electricity for sale. Cash flow from electricity sales represents the majority of the segment’s EBITDA. This segment will also house Biffa’s interests in the JV partnerships with Covanta to develop two new electricity from waste (“EfW”) facilities.
Breakdown of revenue and EBITDA are as follows. Segment allocations for FY Mar 20 are estimates as Biffa has recently consolidated the four segments into 2 larger ones called Collections and Resources & Energy. However, I find the older breakout more informative, especially as the impact of COVID on the various segments differ significantly.
Biffa has done a solid job over the past five years scaling its industry-leading I&C business, growing it from 19% of overall EBITDA in FY 2014 to 57% in FY 2020. I&C margins improved significantly, from 5% in FY 2014 to 14% in FY 2020. This was largely achieved through both organic growth as well as numerous tuck-in acquisitions, allowing its trucks/routes to densify. I&C collections is a solid business, which in a “normal” recession, should be fairly resilient as refuse pickup for any business is an essential service. COVID unfortunately forced nearly all of the country’s businesses to shut down for several months. As long as you provide reliable service, customers rarely are inclined to switch providers, given the nature of the service and its low absolute cost (~£35 per lift). Retention rates are above 90%, with the vast majority of the churn due to business closures.
With I&C driving the majority of EBITDA, Biffa has dramatically improved the quality of its earnings profile since 2014. In 2014, 70% of EBIT was generated by “Energy”, which is selling power from the gas emitted from its landfills. Not only are power prices unpredictable, but the earnings stream is in structural decline (~7% per year) as landfill sites mature and close over time. It is now 22% of overall EBIT and its mix will continue to decline. The only other meaningful commodity exposure lies within the materials recycling facilities (MRFs) found within the RR&T segment, where Biffa’s facilities sort recyclable material (paper, plastics, glass, metal) in return for a gate fee and some participation in the end sale of the recyclates. The prior VIC writeup has excellent background on the China waste paper import ban which has put pressure on MRF operators, as historically the majority of their revenue was tied to the commodity values of the recyclates. In response, the global MRF industry is charging higher upfront gate fees and reducing their overall dependence on commodity values. Historically, Biffa retained 80% of the risk with commodity values. It is now at 45%, and as contracts roll-off, their intention is to get to 20% over the next several years.
Pre-COVID and before considering growth investments, Biffa’s growth profile is modest, with EBITDA growing in the LSD % range. I&C, without any acquisitions, should exhibit modest growth as modest pricing complements volumes being flattish to slightly up. Municipal (residential collections) is essentially an concessions/outsourcing business with a flattish growth profile. The prior writeup discussed some challenges experienced within Municipal a few years ago, but operations (and the larger overall market) has since stabilized. RR&T contains various businesses such as landfill, MRFs and plastics recycling. Landfill is expected to be flattish as modestly declining volumes (as more waste is diverted to other, more environmentally friendly disposal routes) is offset by rising prices (scarcity value as remaining landfill capacity diminishes). MRFs is currently off depressed values (given the China actions) and as mentioned above, the economics will improve over time as new contracts reflect better terms. Plastics recycling is in growth mode and Biffa should benefit from a recently constructed PET plant that came online in March. Growth from the 3 above segments would be offset by the energy segment, for reasons cited above.
While organic growth is modest, Biffa has several avenues to deploy FCF with handsome returns. Ad17’s writeup goes into great detail regarding this.
Continued tuck-in I&C acquisitions. These acquisitions are quite accretive. Head office costs are removed instantaneously and acquired customers are quickly integrated into Biffa’s existing routes and trucks. Increased scale also begets enhanced purchasing power, especially as it relates to disposal costs, the largest variable cost in I&C (50% of overall cash costs). Biffa has been buying these companies at 6-7x EBITDA and quickly brings them down to ~4x on average. The industry remains extremely fragmented (~75% local and regional players), creating a robust acquisition pipeline for the foreseeable future. COVID will very likely cause financial distress among the smaller mom and pops, as reduced route density will crimp profitability.
Closed loop plastics recycling investments. Biffa treats, cleans and re-processes post-consumer plastics, extruding plastic pellets that can be used to replace virgin feedstocks. The principal item produced is rHDPE (recycled High Density Polyethylene), the primary use of which is in manufacturing milk bottles. Biffa’s HDPE plant is the only food-grade approved milk carton recycling plant in the UK, with 18% national market share of HDPE production and demand for 2x what the plant is currently producing. These pellets can be recycled almost endlessly into new milk bottles, and 85% of milk bottles in the UK now contain Biffa material. Biffa is also in process of building a £27.5 million plant to produce food grade recycled PET drink bottles. The economics of these plants are very attractive as they operate essentially on a cost-plus model, with volatility of commodity prices largely removed. The UK regulatory environment provides a favorable backdrop for Biffa. The UK government recently announced that it plans to tax plastic with <30% recycled content, providing strong demand for Biffa’s product.
Investments in EfW plants. EfW plants in the UK are valuable disposal assets due to government tax policy favoring incineration over landfilling. These sites can take a very long time to develop given permitting issues. Biffa has partnered with Covanta to build two new EfW plants, with Biffa owning 50% of the equity in one JV and 25% for the other, for a total equity commitment of ~£70-80 million. Biffa has committed to deliver ~70% of the waste inputs (from their I&C collections), and Covanta will be responsible for plant operations. 75% of the EfW revenue is in the form of gate fees charged to waste collection companies, with electricity generation comprising the remainder. This investment essentially allows Biffa to create a new earnings stream by leveraging its existing cost base. Biffa expects a high teens, after-tax return on equity on their investment. In addition, contribution from these assets will more than offset the expected loss of earnings coming from Biffa’s landfill gas operations.
With judicious deployment of FCF into the above, EBITDA growth becomes more like 5-7% over the medium term.
Unfortunately for Biffa, the journey toward a resilient, more fee-driven business was wildly interrupted by COVID and the ensuing countrywide lockdown implemented by the UK at the end of March. As businesses were forced to close, Biffa saw I&C revenue dip to 50% of pre-COVID levels in April and May. Landfill revenue, which is largely tied to construction volume, suffered a similar dip. The remainder of the business, including residential collections, MRFs, plastics recycling and energy sales from landfill gas was largely unaffected. As the country begins to emerge out of lockdown, Biffa has seen a corresponding recovery in demand. During July, I&C is back to over 80% of pre-COVID levels and landfill revenues have recovered to 70% of pre-COVID levels. Revenues for the entire company, which were 70% of pre-COVID levels in April, have recovered in June to 83% of pre-COVID levels.
Biffa is guiding to £100 mm EBITDA (pre-IFRS 16) for FY 21 (March end), down 35% from FY 20. At that level, FCF should be marginally positive and net debt should be relatively unchanged versus the prior year. Given the huge EBITDA shortfall in FY 2021, Biffa amended its credit agreement to allow for more headroom. As part of that amendment, Biffa was restricted to pursue any of the growth investments mentioned above. To solve for this, Biffa raised £100 mm in an equity offering in June at 200p. The bank amendment’s restriction on growth investments provided for an equity offering carveout, so the £100 mm will allow Biffa to continue its growth strategy for the next several years. Pro forma for the offering, net debt is 2x off a depressed level of EBITDA.
Biffa’s base case is that I&C gets to 90% of pre-COVID levels by the end of this year. However, their view, which I think is a rational one, is that there wouldn’t be much further improvement beyond that in FY 22, as there would be permanent SMB closures and larger corporate customers reduce their footprint. At 90% of pre-COVID activity, there would also be some margin degradation vs pre-COVID levels given reduced route/truck density. Therefore, I think it’s best to formulate a valuation using a new run-rate EBITDA as the base.
As discussed above, residential collections have not been impacted so no adjustment was made for the new run-rate. My assumption for RR&T is 90%, as I am assuming a structurally lower level of construction activity, which would depress landfill revenue. The other components of RR&T (MRFs and plastics recycling) will continue largely unaffected. Finally, for energy, I adjusted the level downward 20% to reflect the continued natural decline of the business and to reflect the fact that UK power prices are lower post-COVID. The company is hedged at much higher prices until the end of FY 21. Regarding valuation, there is an assumption for the value of its JV interest in the EfW plant currently under construction. Assuming original timelines are still valid, this plant should be up and running by 2023. I assumed a 10x multiple for the expected earnings stream, which is a significant discount to where other UK EfW plants have traded. The 2nd EfW plant is still in the final stages of planning but has not yet closed.
A run-rate EV/EBITDA valuation of 6x seems reasonable for a market-leading business providing an essential service. There is a fair degree of capital intensity (mainly trucks and bins), as shown by the less cheap EV/EBITDA-Capex metric. However, as I&C tuck-in acquisitions resume, Biffa has the opportunity to re-leverage their asset network, causing EBIT growth to outperform EBITDA growth.
UK macro – threat of COVID relapses and rolling lockdowns
Exposure to SMEs within I&C collections. Pre-COVID, 55% of I&C revenue was derived from small businesses. Biffa is able to raise prices in this segment far easier than they can with larger corporates. Hence, SMEs are more profitable. A negative mix shift toward corporates would hurt profitability.
Brexit – a “hard” Brexit is still certainly on the table. It is the default scenario in the absence of a trade deal before the end of 2020. A hard Brexit would most likely exacerbate what is already an unprecedented recession in the UK.
Resumption of accretive I&C tuck-in M&A
Continued re-emergence out of lockdown
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