Description

Shares of Cleanaway represent an opportunity to buy a defensive, under-levered, ESG beneficiary that has opportunities to deploy significant amounts of capital at high incremental returns for a discount to fair value.

Cleanaway is a collection of high-quality waste management assets that generate recurring and relatively defensive returns. We believe a combination of industry growth, continued market share gains and margin expansion will facilitate compelling organic EBITDA growth over the mid-term. Cleanaway has an opportunity to accelerate this growth by allocating capital at high returns in two opportunities: (1) Cleanaway’s leading market share and low leverage make it the natural consolidator of the Australian waste industry, and (2) Cleanaway is also best positioned to develop the infrastructure required for Australia to retain and process recycled materials that were previously being exported overseas. Despite this attractive profile, the business trades at a significant discount to waste peers in North American and Australia, which is unwarranted. We believe this valuation discount will continue to close, driving significant equity appreciation.

Company description:

Cleanaway is the largest waste management company in Australia, with the leading market position in most of its markets. Cleanaway is vertically integrated from waste collection to processing and disposal. The company reports three segments.

• Solid Waste Services (73% of EBITDA): Collection, recovery and disposal of household and commercial waste.
• Liquid Waste and Health Services (18% of EBITDA): Collection, treatment and processing of hazardous and non-hazardous materials and liquids. Includes sharps management and medical and pharmaceutical waste services.
• Industrial Waste and Services (10% of EBITDA): Specialized services to infrastructure, industrial and resources markets. Services include drain cleaning and high-pressure water cleaning.

~35% of Cleanaway waste volumes are estimated to be municipal and ~65% are commercial and industrial. The company has little exposure to construction and demolition. This exposure is broadly similar to the large U.S. waste management players.

The great majority of Cleanaway’s revenues are recurring, with 80% being contracted. Most contracts span 3-10 years. Waste management is a reasonably defensive business. Waste volumes are resilient across the cycle.

There is little terminal value risk (no technology risk, offshoring risk, etc.).

Cleanaway has a number of opportunities that should facilitate strong double digit earnings growth over the mid-term:

1) Cleanaway can generate high-single digit organic EBITDA growth over the mid-term

• We believe industry growth and market share gains will facilitate mid-single digit+ organic topline growth
  • The Australian waste management sector benefits from low-single digit volume growth and low-single digit price increases which combined result in mid-single digit revenue growth. Cleanaway is a market share gainer, which should add an additional tailwind. Approximately three quarters of EBITDA comes from the Solid Waste Management segment, and we believe Cleanaway grew this business at a normalized 7% organic growth rate in F1H 2020. This growth was achieved in a reasonably flat GDP environment and is indicative of Cleanaway’s potential for share gain.

• Cleanaway’s CEO, Vik Bansal, has done a good job expanding margins since joining in FY2015. Management has laid out the following “medium term” targets (before AASB-16 accounting changes to facilitate a like for like comparison):
  • Solid Waste Services = FY2019 EBITDA margin of 25.9% -> Target 27.0-27.5%
  • Liquid Waste and Health Services = FY2019 EBITDA margin of 17.6% -> Target 20%
  • Industrial Waste and Services = FY2019 EBITDA margin of 13.6% -> Target “Mid-to high teens”
  • Management has indicated these margin initiatives are based on best practices, and a brief comparison to publicly listed US and Australian comps also suggest there is further margin opportunity. Cleanaway's latest fiscal year EBITDA margins are 22% versus an average of 28% among US and Australian listed pure play waste management companies. CWY's Solid Waste System segment margins are 26% vs. the peer average of 28%.
• The combination of the aforementioned organic revenue growth combined with margin improvement should facilitate high-single digit EBITDA growth over the mid-term

2) Cleanaway has capital allocation opportunities that have the potential to drive EBITDA growth into the double-digits over the mid-term

• A) Cleanaway is well positioned to be the consolidator of the Australian waste management market, which would result in earnings accretion and an improved industry structure.
  • The US waste management market illustrates the value creation that’s possible as a waste management market consolidates. It’s been rewarding to own the US waste management companies (WM, RSG and WCN) as they’ve consolidated the US market. Over the past 5-years, the returns before dividends have averaged 16% vs. the S&P 500 at 6%. The Australian market remains highly fragmented and continues to consolidate.
  • Experts with exposure to the Australian market will confirm that assets can be purchased at 10x EBITDA, which translates to 6-7x EBITDA after the extensive synergies. The synergies are inherently large because you increase density of any overlapping service areas e.g. having 1 truck serve customers in a region that was previously served by 2 trucks at lower utilizations. As support, Canada’s leading public waste management business, GFL Environmental, has completed >100 acquisitions since 2007 at an average multiple of 7x EBITDA.
  • Beyond the accretion that results from acquiring at these valuations, consolidation will result in more rational competitive dynamics that should lead to higher margins and returns on capital.
  • Cleanaway is best positioned to consolidate the market:
    • Cleanaway’s high national and regional market share typically leads to greater acquisition synergy opportunities versus peers.
    • Cleanaway has low leverage. Net debt / EBITDA is ~1.5x versus its peer group at 2.5-4.5x+. On Cleanaway’s FY2019 call, management noted “Our debt is well under control, with a net debt to EBITDA ratio of 1.4x, a level that provides us the flexibility we need in the future to fund selected earnings accretive projects and acquisitions.”
  • As an example, Cleanaway completed the acquisition of competitor ToxFree on 5/25/2018. Cleanaway did the deal at 10x FY2017 EBITDA and 7.1x FY2017 EBITDA pro forma for synergies, resulting in over 25% EPS accretion.
• B) Cleanaway is an ESG beneficiary in that it can provide the infrastructure for Australia’s “circular economy”
  • Historically, a significant amount of recycled materials that were collected globally were exported, typically to China and other countries in the region, where they were either processed under inhumane working conditions or not processed at all (dumped in rivers that ultimately flow into oceans or burned in open air). In response, at the August 2019 meeting, COAG (Council of Australian Governments) committed to ban the export of recyclable waste over time. This creates the need for additional processing capacity in Australia. The Australian government has called for an industry-led approach, and the waste companies are best positioned to provide this infrastructure along with government support. Cleanaway’s CEO, Vik Bansal, discussed this on the FQ4 2019 call (FYE is June 30), saying “We see an opportunity to invest further in the resource recovery value chain by moving downstream and participating in a circular economy… companies like us will have to participate downstream, which gives you the enhanced value of that resource recovery material. That is very, very good for the waste sector.” At their F1H 2020 results, Cleanaway announced that they have already signed an MOU with Pact and Asahi for a plastic pelletizing plant to re-process recycled plastics and “close the loop.” CWY received a grant from the Environmental Trust as part of the NSW Department of Planning, Industry and Environment’s “Waste Less, Recycle More” initiative. We estimate the return on invested capital from this investment is 15% before leverage and view this project as just one of many that will be initiated over the coming years.

Attractive absolute and relative valuation:

• The Australian and North American markets are similar waste markets in structure. Cleanaway is currently trading at 8.8x consensus FY2021 EBITDA (FYE ended June 30, 2021), while comparable US and Canadian waste players trade at a median of 13x NTM EBITDA. The only other Australian publicly traded pure-play waste management company, Bingo, plays in the more economically sensitive construction and demolition market (which Cleanaway does not) and trades at 11x EBITDA. Cleanaway’s valuation discount exists on FCF (CFO – Capex) as well, with Cleanaway trading at 17x our estimated FY2021 free cash flow versus the peer group at 25x FCF.
• We believe this valuation is compelling for a defensive business that has little terminal value risk and is well positioned to deliver attractive organic and in-organic growth over the coming years. If Cleanaway were to trade at the median peer EV / EBITDA multiple, it would result in 60% upside. If they were willing to bring their leverage to peer averages via incremental M&A and trade at the median multiple, shares would appreciate >80%.

We believe the valuation gap between Cleanaway and peers will continue to close:

• Cleanaway’s equity has been re-rating as investors move beyond a complicated history that is no longer relevant
  
  • The company came to the public markets as “Transpacific Industries” in May 2005 and subsequently acquired a number of economically sensitive assets. This left Transpacific with various different businesses, including the manufacturing of commercial vehicles. Transpacific Industry’s high leverage and more commodity- / economically-sensitive structure resulted in the company struggling through the last recession and the company had to undergo a restructuring that included a number of CEOs, the sale of non-core assets and equity issuance to delever the balance sheet. From the last recession through to 2015, the business traded at very low multiples. Current CEO Vik Bansal joined in 2015. Bansal is an excellent manager who has been successful in cutting costs and refocusing on waste. He changed its name from “Transpacific Industries” to “Cleanaway” in 2015. Since Bansal’s arrival, EBITDA has compounded at 19% (FY2015-FY2019), EPS at 25% and the equity at 24%.
• Cleanaway has faced short-term idiosyncratic headwinds that are now better understood by investors
  
  • Cleanaway’s EV / NTM EBITDA multiple was approaching that of peers, at 12x in mid-2019, but in mid-2019 shares fell due to a deceleration in EBITDA growth that resulted from two factors: (1) Large declines in the price of Old Corrugated Cardboard (“OCC”) which impacted Cleanaway due to their collection and sale of cardboard. (2) Lost waste volumes in Queensland due to a change in landfill tariffs that reduced the relative attractiveness of a regional landfill. Cleanaway’s F1H 2020 results, which were announced in mid-February, beat consensus and indicated that management had properly factored these temporary headwinds into guidance. Further, incremental disclosures reassured investors that the business has limited commodity price exposure (we believe commodity profit is a low-single digit percentage of EBITDA). Shares re-rated strongly on these results, but have subsequently fallen again on COVID-19 concerns.

COVID-19 considerations:

• Waste management is recurring in nature and waste volumes and price are relatively resilient in recessions. Over the near-term, COVID-19 creates uncertainty given lockdowns will result in less activity at many commercial enterprises during F2H 2020 ended 6/30/2020 (bars, restaurants, certain retailers, etc.). Australia has done an excellent job of containing COVID-19 with new cases at less than 20 per day over recent weeks. There are initiatives to start to re-open the economy so volumes should recover in FY2021. For long-term investors, we believe these near-term challenges are more than offset by longer-term opportunities for share gain and M&A, as weak and over-levered peers struggle. Bansal and his team are capable operators and capital allocators. When the aforementioned commodity price pressure hit in late 2019, Cleanaway acquired the senior secured debt of one of Australia’s largest recycled material players, which provided a pathway to buying the entire business out of bankruptcy. 

Catalyst

Continued market share gains. Accretive industry consolidation. High returns on capital allocated to build the infrastructure required for Australia's circular economy.