Description

Should not be considered investment advice. May contain errors and includes subjective views. 

Summary

Lassila & Tikanoja (“L&T”) is a Finnish waste / environmental services and facility services business. Temporary issues and lack of guidance have resulted in a substantial mispricing, despite L&T’s scale and long-standing strong competitive position in a good local market. There is a near-term catalyst to value realization as L&T is due to dispose of its low-margin Facility Services businesses, while the whole company also appears to be a likely buyout candidate.

I hope you enjoy my analysis below!

LASSILA & tIKANOJa

    1. Company Overview

Lassila & Tikanoja (“L&T”) is a Finnish waste / environmental services and facility services business headquartered in Helsinki, with 8.5k employees and 50+ recycling plants / waste terminals / transfer stations covering 50k corporate customers (including local blue chips such as Neste, Kesko, YIT and Raisio) and 100k+ households. In 2022, the company collected 728k tonnes of waste from customers.

History

L&T has a long and winding history, beginning with its founding in 1905 in Vaasa, Finland, as a local wholesaler of various household products, foods and more. Over time it grew to be the biggest privately owned wholesaler in the Nordics.

Fast-forwarding: the company IPO’d on the Helsinki Stock Exchange in 1961 and, later on, in the 1980s underwent an acquisition spree, leaving it a conglomerate at the beginning of the 1990s. In 1995, L&T acquired the remainder of its partially-owned subsidiary Säkkiväline, which had become focused on waste management, cleaning, property maintenance and similar services. In 2000, Säkkiväline acquired WM Ympäristöpalvelut to become the leading provider of environmental management services in Finland.

L&T took its present form in 2001, when the non-core subsidiary (non-wovens business Suominen) was spun off. Subsequently, L&T replaced the Säkkiväline brand name. Since 2001, there have been other M&A transactions, but of less magnitude and within the waste / facility services space.

Operations Today

Today, L&T has four business lines in two different segments, overview below (market positions as reported by the company on the Nov ’23 CMD):

Circular Economy

• Environmental Services
  • Operates only in Finland
    • Market position: #1 in Finland
  • Provides
    • Waste Management
      • Consulting / advisory
      • Waste containers, compactors and bins
      • Waste management / logistics
    • Recycling and processing
      • Nationwide network of waste terminals in Finland
      • Across whole value chain:
        • Pre-treatment, Storage, Processing and Secondary raw materials
  • L&T pride themselves on the most comprehensive service portfolio in the market
  • Majority of sales from Industrial sector, thereafter equally split between Public Sector / Municipalities and Housing sector, thereafter mix of other sectors
• Industrial Services
  • Operates in both Finland and Sweden
    • Market positions: #1-2 in Finland and #3-4 in Sweden
  • Provides
    • Environmental construction services
      • Soil remediation
      • Treatment centre operations
    • Process cleaning
      • Services for industrials
      • Sewer maintenance
    • Hazardous waste services
  • Majority of sales from Industrial sector, thereafter Public Sector / Municipalities, thereafter mixed sectors

Facility Services

• Facility Services Finland
  • Provides
    • Office and property cleaning (#2-3 position)
    • Property maintenance (#3-4 position)
    • Technical services such as technical maintenance / HVAC / energy management (#7-9 position)
• Facility Services Sweden
  • Provides
    • Office and property cleaning (#10+ position)
    • Technical services / property maintenance (#4-5 position)

2022A Revenue and EBITDA Breakdown (€m)

It is worth noting:

• That slightly more than half of revenue is from the Circular Economy business, while it accounts for more than 84% of ‘22A EBITDA
• Most of the business is in Finland, even more so for Circular Economy
• Most of the revenue is from Long-Term Contracts
  • Nonetheless, all types of revenue except Sales of Equipment and Materials are paid upfront while revenue is recognized over time (distinction between long-term and separately ordered seems narrow)
• Of minor importance, but to understand what it is:
  • Sale of Equipment and Materials comprises sale of compactors and balers in Environmental Services (€93m) and some fuels and materials sales from Industrials Services (€6m)
  • Lease income is leasing of compactors and balers in Environmental Services

Board of Directors and Management

L&T’s BoD and management seem able with solid backgrounds at local blue chip corporates and some financial institutions (Vice Chairman has long experience in investment banking). CEO Eero Hautaniemi, came onboard in 2019 after 11 years as CEO at Oriola (sizeable Finnish drug distribution co). Regardless of who has driven the agenda, L&T has resolved to focus on the high-margin Circular Economy divisions (more on this below), which I think speaks to the leadership’s competence.

However, insider ownership is somewhat low (CEO’s €468k shares vs. €459k ‘22A base salary), and most of management shares seem to be from incentive plans. The share-based incentive plans for managers were recently increased in size and span, which could help align interests further, but they are still modest. For what it’s worth, the only sizeable acquisition outside incentive plans in the LTM is Vice Chairman Sakari Lassila’s acquisition of 150k shares in March 2023 at ~€11 per share. Nonetheless, it still seems that BoD and management are committed to shareholder value.

As of 8 January 2024:

Ownership

Overall ownership of L&T is fragmented, as seen below per 31-Dec-22.

While a bit dated, the only major holdings flagging since then is that Mandatum went below 5% in June 2023. As such, the company lacks a dominant anchor shareholder.

    2. Recent Developments

The past 4 years have been difficult for L&T, as:

• Covid-19 led to uncertainty in demand and operational planning
• Covid-19 also saw the beginning of very high illness related absences, which is a costly burden on margins given planning issues and cost of replacement staff
  • In particular for Facility Services
  • High # of absences continues
• Subsequently other labour issues and costs increases took place
  • Scarcity of labour and increased employee turnover 2021 onwards
  • Strikes / industrial action
    • Notably by Transport Union in Finland (Q1 2023)
  • One-off costs related to resolving strikes (visible in EBITDA)
  • Increased salaries
• Accelerated costs inflation in other expenses

The EBITDA margin dropped from 12.7% in 2019A to 11.3% in 2020A while sales decreased. As cost inflation later accelerated, L&T continued to suffer given the contractual nature of its revenues. The company has communicated these issues very clearly, perhaps too much so as most earnings calls and report commentary seem to emphasize the issues facing the business, but L&T has taken a multitude of actions to address problems and subsequently improved margins noticeably in the LTM – more on this in the Valuation section.

Historical Financials

NB:

• Adjustments to EBITDA incl. adjustments from EBIT to adj. EBIT, but differ from company segmental reporting as the Q4 ‘22A €4.3m gain from sale of renewables business is attributed to Environmental Services not Overhead
• Capex here refers to purchases of PPE and intangible assets from the Cash Flow statement
  • The company reports divisional Gross Capex figures that do not make sense (by including M&A and not adjusting for acquired cash etc.)
  • True Capex per division is estimated by multiplying true total Capex (purchases of PPE and intangible assets from Cash Flow Statement) by divisional % contribution to Gross Capex

In addition to ongoing operational initiatives, the company has launched an overarching strategy shift. On October 25^th 2023, the company announced it had completed a strategic review and decided to focus on the Circular Economy segments. Alternatives for the Facility Services businesses are being assessed with the goal of completion by Y/E 2024.

    3. Business Quality

Zooming out from short-term challenges, and looking at L&T’s business quality, it exhibits favourable characteristics:

• Long-standing scale and cost leadership in Circular Economy business in Finland
  • Virtuous cycle of scale-enabled cost leadership through
    • Operating leverage
      • Fleet utilisation
      • Processing capabilities
      • Material flow efficiency
    • Customer relationships and insight
• Favourable market dynamics
  • Diverse, fragmented customer base for both Circular Economy and Facility Services
    • No major customer concentration
    • Diverse sectors served
  • Barriers to entry in Circular Economy given investment needs and runway to scale
    • Hard and costly to replicate network of waste terminals
    • Even more so considering the logistics organisation and labour requirements
  • Circular Economy business is hard to disrupt with new technologies
    • Recycling technology is half the battle, sorting and logistics also important
• Long-standing brand name, which confers credibility
  • Likely very important selling point for corporate clients
    • More so in Circular Economy as environmental matters have large downside in non-compliance with regulations or other mismanagement
  • Likely yields some pricing power
• Established customer relationships on the back of long-standing industry leadership
  • Enables cross-selling
• Management seems serious and focused on the right things – i.e. shareholder value

    4. Valuation

A) Peers

L&T identified below competitors in their CMD pres, publicly listed names in bold. It is worth noting that many names are PE owned.

Drawing on the above, but noting that most of the competitors are private, I include below peers. US names included for reference and to show aspirational upside.

Per CapIQ as of 5^th Jan, except

• Renewi’s EV adjusted to include very sizeable provisions
• All lease expenses are extrapolated from 2022A

B) Projections and Targets

As the basis for both a DCF and multiple-based valuation, I lay out one central projection case below that is a conservative appraisal of likely outcomes.

Growth

There is company guidance (confirmed in Q3 report) that 2023E will likely be in line with 2022A in terms of total sales and EBIT. Thus, as a starting point, it would make sense to assume:

• Industrial Services grows 5.6%, in line with LTM growth
• Both Facility Services Finland and Sweden decrease (1.2)%
  • This errs on conservative side as these are the lowest margin divisions and these divisions are refocusing their customer contract portfolios, i.e. likely greater decrease than (1.2)%
    • In LTM the divisions shrank by (1.2)% and (1.4)% respectively
• Eliminations of 0.7% of divisional sales, in line with historicals
• Given above, Environmental Services would have to decrease by (0.5)% from 2022A to arrive at €845m total revenue in 2023E (2022A: €844m total revenue)
  • In 2022, €35m of sales came from a JV that was separated mid-year (stake value included in EV bridge), i.e. like-for-like sales were €285.8m, same as in LTM
    • Like-for-like growth is ~12% vs 2022A
  • While this implies a very strong Q4, growing Environmental Services as opposed to Industrial Services is the more conservative assumption as it has lower cash conversion

Looking beyond 2023E and drawing on the discussion of business quality, it seems feasible that L&T can protect its market share and most likely will continue to operate from a good competitive position. It seems the company should be at least be able to grow in line with the market, and most likely outpace the market, given its competitive strengths.

On the CMD, L&T relayed estimates for market growth:

• Environmental services
  • Market size: €1.8bn
    • €0.7bn for Waste Management
    • €1.1bn for Material Processing
  • Growth of 0-3% for Waste Management and 3-5% for Material Processing
• Industrial services
  • Market size: €1.1bn
  • Growth of 2-5% 
• Facility Services
  • ~€10bn market size with growth of 2-5%

But the above seems to understate the growth opportunity massively as:

• There are adjacencies of €2bn+ identified by the company itself
• The scope of the market is set to expand into new materials and waste streams
  • There are numerous EU recommendations and regulations for increased recycling and more stringent environmental controls
  • There are numerous Finnish Government initiatives / targets for increased recycling
    • for example, the aim to double resource productivity and circularity of materials by 2035
  • There is increasing demand for recycled materials
  • New recycling processes are becoming commercially viable

It is worth to hone in on the Finnish Government targets for more recycling:

• The Finnish government has in recent years given municipalities increased responsibilities for waste management while at the same time wanting more recycling
• Municipal waste capacity has grown by 18% p.a. from 2007-18, primarily in incineration
  • So much so that waste is being imported to be incinerated
• More recycling (as opposed to incineration) seems to be emphasized politically
• The EU is tightening regulations around exporting waste
• The general technological trend in waste management has been a transition from landfilling to incineration to recycling nowadays
  • It seems the economic value of recycling is surpassing incineration in many cases

Conclusion from this: municipalities will have to close incineration capacity as it becomes unviable (given low volumes and/or regulations) and are unlikely to replicate economically-sustainable recycling at scale, meaning very large waste streams will go elsewhere for recycling, benefitting L&T.

Translating the above into a growth figure is exceedingly difficult, but:

• A report by Verdantix puts global environmental services market at 6.3% CAGR in 2022-28E
• Consensus for European Waste Peers has an average 6.9% CAGR in 2022-24E
• Consensus for Facility Services Peers has an average 6.4% CAGR in 2022-24E

As such, it seems reasonable to assume:

• Ramp-up growth with 6.0% for all divisions in 2024E
• Peak growth of 6.5% for all divisions in 2025E
• Thereafter 50bps decrease p.a. until 2027E
• Thereafter converging to 2.5% growth in 2033E
  • i.e. 40bps decrease p.a.
• Eliminations at constant (0.7)% of sales, same as in LTM, ‘22A and ‘21A

The group sales CAGR is 4.5% ‘22A-‘26E and 4.6% ‘22A-‘27E, which is below one of the company’s two sparsely communicated targets of 5% “long-term growth”.  

EBITDA Margin

Long-term EBITDA margins should be at least in line with LTM margins, and probably above. More concretely, considering the backdrop of the LTM EBITDA margins, they hint towards the higher long-term earnings power of the business, as:

• There were numerous adverse effects during the period of margin improvement
  • Slow pass-through of heightened costs into pricing given long-term contracts
  • Strikes across divisions (notably in Q1 ’23 by Transport Union in Finland)
    • extraordinary costs in relation to collective bargaining / industrial action visible in EBITDA across all divisions in LTM, i.e. overtime and resource planning costs
  • Salary increases following strikes are visible in EBITDA
  • Abnormally high sickness absences and employee turnover leading to more overtime and HR costs
  • Also visibility of other heightened costs
• Profitability uplift has been from structural changes that are sustainable
  • Circular Economy businesses have improved efficiency, rationalizing costs and let go of some staff
    • Environmental Services’ renewable energy business merged into separate JV (stake value included in EV bridge), in mid-2022A this had sales of €57m with an EBIT margin of 1.6%
  • Facility Services Finland has undergone an improvement programme resulting in better efficiency and planning
    • Also closing out unprofitable contracts and focusing on profitable customers
• Labour situation has improved across all divisions
  • Less costly substitutions and resource planning needed going forward
  • Multiple efforts have been undertaken to ensure resilient labour situation over time
    • Cooperation with employment agencies, municipalities and taking in foreign workers

In addition, there are more probable increments to margins in the near to mid-term:

• May be more price improvements in long term contracts
• Continued improvements to Facility Services margin
  • CEO commented that he sees no reason why Facility Services should not be able to maintain 5% EBIT margins over time, which means significant uplift to EBITDA
    • D&A & Impairments at 3-4% of sales, in line with historicals, would mean 8%+ EBITDA margin
  • Facility Services Sweden is implementing the same changes as Finland and is “12-18 months behind” per CEO on CMD
• Sorting capacity and platform “allows for expansion” per CMD commentary
  • There is likely material unutilized capacity and operating leverage to go with it
• 2025E onwards will see gains from the ongoing ERP system upgrades according to CEO, although impact is likely minor

As such, it seems reasonable to assume:

• Environmental Services continues at 19.3% EBITDA margin
• Industrial Services continues at 18.7% EBITDA margin
• Facility Services Finland
  • 5.0% EBITDA margin in 2023E, constant at LTM level
  • Thereafter gradual uplift to 7.5% in 2028E onwards
    • 50bps annual uplift
• Facility Services Sweden
  • 2.0% EBITDA margin in 2023E, slight uplift from LTM level
  • 170bps uplift in 2024E, same as that of FS Finland in LTM
  • Thereafter gradual uplift to 7.2% in 2031E onwards
    • 50bps uplift p.a.
• No positive Overhead EBITDA as was the case in ‘22A and LTM

This checks out vs the guidance for 2023E, where the company has said that FY 2023E will likely be in line with 2022A in terms of total sales and EBIT. If D&A and Impairments remain at constant LTM 7% of sales, projected EBIT margin would be at 5.2%, not far off from the 5.3% in 2022A.

Under the above assumptions, EBITDA margin stabilizes at 13.8% in 2031E onwards, which seems quite conservative for the above-mentioned reasons. Also, for what it’s worth, the second of the company’s 2 sparsely communicated targets: 15%+ ROCE would in 2022A have implied a group EBITDA margin of ~14.2%.

In light of the Peers, these margin assumptions also seem reasonable:

• Circular Economy margins are below consensus margins for Seche
  • the best comparable peer as a pureplay environmental services business
  • Seche also has targets for 24-25% EBITDA margin by 2025E
• Facility Services margin assumptions ramping up slowly towards listed peers

Capex

It is worth making note that:

• There is an ongoing ERP upgrade
  • €6.2m realised in 2022A, taking this out would mean total group Capex at (3.3)% of sales
  • this programme is due to be completed by 2025E
• LTM has seen heightened Capex given long lead times for trucks and machinery per CEO commentary

As such, long-term Capex should come down. Per division it is then assumed:

• Environmental Services
  • 2023E: slightly larger absolute amount as for LTM at €31m, meaning 100bps less as % of sales at 9.7%
  • Thereafter 100bps less p.a. ‘24E – ‘25E, stabilizing at 7.7% in 2025E onwards
    • This is more % of sales consensus mean for European Waste Services peers ‘23E-‘24E
    • Broadly in line with Veolia consensus estimates
• Industrial Services
  • 100bps less as % of sales p.a. 2023E-2025E
  • Stabilizes at 5.3% of sales in 2025E onwards
  • More than double that of Kreate, a pureplay environmental construction business
• Facility Services, both divisions
  • 1.0% of sales constant, which is a big step-up from LTM and more than consensus estimates for best fitting peer Coor in ‘23E and ‘24E
• Overhead at 1.0% of total divisional capex added on top of above

The group thus stabilizes at Capex at 4.3% of sales from 2025E onwards.

Other Assumptions

• Leases Cash Flow at constant (3.0)% of sales, same as per 2022A, which is more than the (2.8)% of sales for 2021A
  • Split per division according to divisional D&A contribution ‘22A for SOTP
• NWC at (3.0)% in 2023E, then constant (3.5)% of sales, same as for 2022A and less negative than the (4.8)% in 2021A
• Shared based compensation assumed at €1.0m p.a.
  • Under the company’s recently expanded share-based incentive programme for 2023-2027 there is a maximum of 321k shares distributable
    • Dividing by 4 years and multiplying share price of €10 = ~€800k annual charge, which rounds upwards to €1.0m
• Taxes on EBIT at 20% Finnish CIT
  • D&A at slightly above Capex (like in historicals) but converging to Capex by 2029E

Summary

 C) Valuation Calculation

   i) DCF

• FCF per above with final projection year in 2033E
• Discount rate 10.0% with 2.0% perpetual growth rate
• €610m EV excl. leases
  • Unlevered FCF NPV of €306m
  • Terminal Value NPV of €303m

   ii) Multiples

Public peers

• Environmental Services and Industrial Services divisions valued at European Waste and Enviro Services Peer multiples
  • Unallocated Capex and Lease expense are also valued at these (higher) multiples
• Facility Services divisions valued at Facility Services Peer multiples

Using the projected 2024E figures and applying median ‘24E peer multiples visible above:

Precedent transactions

Precedent transactions also support a significantly higher valuation.

Nordic Facility Services:

• Mar-23: Caverion at 9.8x EBITDA by Triton
  • Public buyout in Finland
  • 2022A: 6.1% EBITDA margin, up from ~5% in 2021
• Jul-21: Polygon by AEA at higher multiple according to credible sources

Nordic Waste and Environmental Services

>10x EBITDA multiples according to credible sources

• Mar-21: Sortera by Nordic Capital
• Sep-20: Suez by PreZero
• Dec-17: Norsk Gjenvinning by Summa Equity

   iii) Summary

Drawing on the DCF and SOTPs, L&T is worth, on EV excl. leases basis, €585-705m and even more if applying precedent transaction multiples.

Above range corresponds to 5.8-6.9x EV incl. leases / ’24E EBITDA. For reference, L&T’s annual average NTM EBITDA multiples were 7.9x and 7.0x in 2018-19, respectively (per CapIQ).

EV (excl. leases)-to-equity bridge:

• Gross debt of €141m, including
  • €7.8m provisions
  • €1.5m retirement benefits
  • €5.5m deferred consideration for NCI in SVB acquisition
• Other financial assets comprise €17m reported value of investments / value of shares in JV

With deliberately conservative assumptions, there is at least a 27% upside from current share price, possibly far more.

 D) Additional upsides

In addition to the valuation assumptions above, there are numerous levers that are more difficult to quantify or more difficult to underwrite, but that could have a significant positive impact on the valuation:

• Value accretion from M&A
  • L&T have identified €500m+ M&A targets in Finland and Sweden (per CMD)
  • Business services like these lend themselves well to M&A, as there are obvious synergies in
    • Overall scale and product breadth for revenues; cross-selling opportunities
    • Cost synergies from removing double overhead
    • Professionalization of smaller independent contractors
• Higher growth than assumed
  • As discussed above, above valuation makes conservative assumptions for growth
• Higher profitability with margin increase given operating leverage
  • Converging to Seche’s targets of 24-25%
• Converging to US peers in terms of margins and multiples
  • Admittedly unlikely as US market is larger than the Finnish one and growing, while regulations limit new entrants, thereby yielding more operating leverage

  5. Why Does This Opportunity Exist?

The market is punitive towards L&T as visible in the lower multiples assigned to the company relative to peers and the consensus estimates that differ from the above projections – this can be chalked up to:

• Market short-term memory
  • Recent history of issues that have been well publicized (strikes and other cost pressure)
  • Overly pessimistic view on long-term cash generation
• Sub-optimal investor communications
  • Overly acerbic earnings call commentary and report commentary
  • No clear targets translating the great prospects of the company
    • Only “5% Long-Term Growth” and “15%+ ROCE”
  • Other minor examples of other poor disclosures
    • Environmental Services’ renewables JV could be more clearly reported to show pro-forma like-for-like growth
    • Focus on EBIT as opposed to EBITDA in reports and on calls
    • Headline Capex figures don’t make sense (gross capex including M&A)
• Somewhat obscure and underfollowed from an international perspective
  • Relatively small size company with ~€380m market cap
  • Only local research coverage by Inderes, Nordea, OP and SEB (per company website)

  6. Catalysts

Soft Catalysts

Improved investor communication could help with market understanding of long-term earnings power. Management seems to be improving, for example with the CMD.

Thankfully actions speak louder than words and cash generation should over time converge the intrinsic value and the share price

Hard Catalysts

Ongoing share repurchases can help stifle the valuation shortfall and BoD are authorised to buy back up to 5.2% of NOSH since the 2023 AGM. However, per the company website, only ~8.5k shares have been repurchased in the past year.

More interesting, as the company has resolved to focus on its Circular Economy business, Facility Services will either be divested or spun off – both scenarios are likely to materialize value in the not too distant future:

• Remaining Circular Economy businesses likely to enjoy multiple uplift towards listed peers
  • Standalone company with higher ROCE in a growing market and a more straightforward equity story
• Listed standalone Facility Services unlikely to be worth much less than currently implied
  • Less complexity is more likely to converge multiple towards peers than to drive further valuation gap vs peers
• Sold standalone Facility Services would likely be at higher multiple than listed peers
  • High PE interest in business services and facility services / maintenance
    • Likely high multiple given control premium + likely more aggressive business plan with slashed costs and/or roll-up story
  • Precedent transactions indicate high multiples

As a whole, the company should also garner PE interest, given:

• There are multiple precedent business services buyouts by PE in the Nordics, in particular around environmental and facility services
  • Multiples here have been far higher than L&T currently trades at
• Internationally, PE’s interest in environmental services seems even stronger
  • “The scarcity of assets in hazardous waste treatment and management has never been more apparent than in 2023” – the Deal article December 22, 2023
  • “Waste sector attracting attention of private equity firms” – Private Equity Insights article June 21, 2022
  • Some transactions
    • EQT / Heritage Environmental Services in 2023
    • CPP / FCC Medio Ambiente in 2023
    • Ardian / Attero in 2023
    • ECP / Biffa in 2023
    • Heartwod partners / Amlon in 2022
    • EQT / Covanta transaction in 2021
    • KKR / Viridor in 2020
• L&T stands out as attractive
  • Ownership is fragmented, no anchor shareholder that could block buyout
  • L&T has never been PE owned and presents a primary buyout opportunity
    • Considered particularly attractive as there are likely more improvements possible than at an asset that has been passed between sponsors
  • EV around the ~€500-1,000m mark is in the sweet-spot for many PE houses
  • Illustrative 5-year LBO maths return 20% easily
    • Entry at €680m EV in June 2024, 6.0x ‘24E EBITDA
    • 3.0x leverage at 8% pre-tax interest
    • Cash generation per above DCF
    • Exit at €1,100m EV in June 2029, 7.0x ‘29E EBITDA
      • Exit equity of €915m, 20% IRR

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Catalyst

 Soft Catalysts

• Improved investor communications
• Cash generation

Hard Catalysts

• Share repurchases
• Sale or spin of Facility Services
• Potential buyout