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Cleanaway – CWY

Ay caramba! What was thought to be defensive earnings for waste collection company Cleanaway (CWY) just had a 10 tonne rubbish compactor truck driven through it.

A number of price upgrades a few months back appear to be on the nose like week-old rotting prawn heads. CWY’s price fell to $1.85 from around $2.20, instead of aiming for a targeted upgrade to $2.60, on higher earnings.

Cleanaway is Australia’s biggest domestic and tox solid waste management company, with what we though were rock solid margins backed by multi-year contracts. The firm has more than 3,000 collection rubbish collection vehicles and 5,000 employees. It is becoming imperative to do more recycling with waste since China banned the global importation of 30 million tonnes annually of recyclable materials.

Rather than guiding to a modest increase, CWY has pointed to flat earnings for first half 19 earnings.  And possible early FY 20. And the share price fell.

Waste recycling economics grew at just under 3% a year for the past decade, signalling the defensive nature of the sector’s earnings despite hiccups along the way.

And the current price makes it attractive to add more, I think, to portfolios.

The big difference between municipal and commercial waste is the first generally is considered recession proof or defensive, while building and demolition waste is more cyclical.

And the role of government, through the form of waste disposal levies is becoming more critical in helping building out recycling infrastructure for waste which otherwise ends up in landfill. These levies, possibly, are the biggest threat to the industry. But it is highly unlikely the levies will decline when core waste growth has a high annual growth rate.

These factors mostly are not new. And high single, possibly double-digit earnings growth gets pushed out to around the FY21. We are looking in between for a period of consolidation and for the share price to build a base around the $1.85 level. Before slowly retracing over a longer period to a modestly reduced price target of around $2.40 -$2.50.

There is no doubt CWY’s earnings are more stable and defensive than those of Bingo in the volatile cyclical building/demolition space. There are lower barriers to entry to Bingo’s part of the market. Whereas Cleanaway is focusing on the next step of integration for plants to divert rubbish from landfill and convert it to energy. One plant alone in Sydney’s western suburbs is expected to cut landfill volumes by at least 500,000 tonnes a year. Makes CWY potentially a significant energy contributor to the east coast energy grid.

Return on equity over the next couple of years is a modest 7%. Pitched against single digit economic growth in Australia, this looks respectable. Producing fully franked dividend yields of around 3%.

Between 2020 and 2022 reported profit is expected to increase from $137 million to $180 million with a commensurate increase in earnings per share from just over 7 cents a share to just under 10 cents a share. The price earnings multiple falls from a current 24 to 19 times – again highlighting a premium to market places on defensive earnings. Otherwise CWY would trade on something similar to long term industrial p/e ratios of between 12 and 14 times. And I don’t think the market is going lose faith in the higher p/e. Particularly when CWY management is focusing on cost reductions in a market where global price stability is re-entering for recyclable commodities like cardboard. 

CWY interestingly trades at a discount of around 13% to its global peers and various joint recycling ventures with private equity partners puts the stock under the takeover microscope. More so if that discount valuation blows out due to unforeseen circumstance.

As both state and the federal government realise there has to be national, rather piecemeal strategy on recycling, the attractiveness of Cleanaway becomes more obvious to a wider investment market.

So back the truck up is our suggestion at current prices. 

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