Cleanaway Waste Management Limited (CWY) Earnings Call Transcript & Summary

[Audio Gap] With me is our CFO, Brendan Gill. So let me start the presentation. I assume you have the copy of the presentation in front of you and also take it that you have seen our ASX media release and that you have a copy of our presentation. I will also take it that you have read these notes on Slide 2 of this pack. And in that case, can I ask you to please move to Slide 3? On the agenda slide, I will run through the safety and environmental update, group performance and segment performance, Brendan will cover statutory NPAT reconciliations, balance sheet, cash flow and debt. I will circle back to update you on key strategic initiatives, namely capital expenditure, landfill remediation, footprint 2025, including SKM Toxfree and reannounced -- today's announced plastic pelletization plant. I will finish the presentation with our priorities for the remainder of the year and our FY '20 outlook before opening the lines for questions. So moving on to Slide 4. Our business faces -- this is our safety environmental slide. Our business faces daily operational and situational hazards, which form part of the standard ecosystem of the waste sector. We have a responsibility to ensure all our employees and contractors go home and in the same condition they arrive for work. Our equipment, especially mobile assets is in continuous interaction with the general population every day and the safety of all involved remains an ongoing #1 priority. Our TRIFR, which now includes Toxfree and other acquisitions is slightly improved on the rate we reported last year. While we have not seen an increase in our frequency of incidents, goal 0 is our target, and that's exactly what we want to get to. It's only possible by having good balance between administrative and engineering controls, with the right culture and behaviors. We are investing our efforts in all of the above, but clearly, we have work to do. This is and will always be a major area of focus for us. Moving on to Slide 5. This slide provides highlights of our first half '20 underlying results, our progress on the key strategic initiatives and our outlook statement for FY '20 full year. Rather than repeating myself, Brendan and I will cover each of the items mentioned here in the following pages. On Slide 6, I'm again pleased to report results, which delivered growth and on our promise and comments. Revenue and earnings have all grown during this last half. Net revenue up 0.5% on first half '19 and 2.5% -- or 2.4%, sorry, on second half '19 to $1.07 billion. Net revenue ex commodities grew organically by 2.3% on first half '19 and 5.2% on second half '19. Underlying EBITDA pre AASB16 up 2.5% to $234.6 million. Cost initiative, operating leverage and Toxfree synergy benefits drove an improvement in EBITDA margin to 21.9%. Underlying EBIT pre AASB16 up 6.8%, and EBIT margin improved again to 11.7%. Underlying NPAT up 13.7% and EPS up 15.2% on first half '19. We have again included NPAT on this side, which reflects a 12.3% increase compared to the first half last year. While cash conversion was strong at 97.4%, operating cash flow declined to 20.2% to $140.1 million pre AASB16, primarily due to a prior period included a one-off tax benefit of $25 million, which was declared then, higher FY '20 remediation costs as planned and as committed as we enter the final phase of legacy spending. Both of the above we declared earlier than expected -- was earlier and were expected. We have declared an interim dividend of $0.02, which is 21.2% up on the corresponding half and is fully franked at 30%. The dividend represents a payout ratio of 53.2% of the underlying NPAT. Now turning to Slide 7. It goes without saying that improvement journey continues. This slide and the next slide are included to give you an indication of the improvements we have made in all our key financial metrics over the past 5 years. We've also shown each metric pre and post AASB16 giving clarity and full transparency to the impact on our results due to change in the accounting standards. Moving on to Slide 8. The operational improvements we have made along with our disciplined approach to cash have continued to drive an increase in shareholder returns. I'm particularly pleased with the consistent growth of EPS, free cash flow and dividends. We passionately believe Cleanaway still has significant number of growth opportunities ahead, and hence, our work continues. Sector thematics, whilst challenging at times, are most exciting and rewards exist significantly -- significant rewards exist for good quality strategic scale player. I will now cover the operational results on the following slides. So turning to Slide 9. We committed -- on Slide 9, we committed post AGM to give line of sight to the commodity revenue exposure. As you can see from the first half comparison over the years, revenue from the sale of commodity is a declining contributor to our business. It represented only 3.3% of the net revenue for the first half of this year. We have taken significant action to remove rebates paid to the customers, and we expect a very near future, no customer will be paid rebates on solid commodity pickup and processing. This is to mitigate the impact of the declining commodity prices to the bottom line as there is not enough margin for us share. On top of that, we have signaled further price increases for collecting and processing of any co-mingle recycling waste. The business previously faced increasing cost of sorting and with reduced commodity prices gate fees at MRF are going up. We have taken appropriate action at all of our MRFs around the country. It is worth noting that this is a second year of year-on-year decline in commodities revenue. It is also worth noting that excluding commodities, our organic growth was 11.8% in first half '19 over first half '18 and 2.3% for the group in first half '20 over first half '19 in a flat market. Moving to Slide 10. There has been a lot of questions around the defensiveness of Cleanaway, and hence, we wanted to provide characteristics of our revenue by each segment. The first thing to note here is our exposure to general economy through a wide customer base across every market segment and hence, a consistent theme around comparing a strategic degrowth. Secondly is the long contractual nature of our business across each of the segments. And thirdly, is the spread of the contract with recurring revenues and most of them include a price adjustment mechanism. The contractual nature of our customer relationships, integrated value chain across multiple waste streams and ownership of 100-plus price assets spread across the country is what gives our customers comfort in our ability to manage waste transparently through the value chain. Cleanaway is a route density business and, hence, has a strong element of operating leverage, which we have demonstrated successfully in the last 5 years. Needless to say, though, and mathematically in a slowing or a flat economy, cost on becomes critical to preserve operating leverage, as we have already implemented and demonstrated in FY '20 first half. So turning on to Slide 11. The solid waste services segment covers the collection, recovery and disposal of solid waste with the waste streams generally including putrescible, inert household and recovered waste. Core customer sectors include municipal, commercial and industrial where these waste streams are processed through a price infrastructure assets, such as resource recovery and recycling facilities, waste transfer stations and landfills. This segment was hit by commodity price impact and Queensland Post Collections revenue dropped this half. Despite all the challenges, this segment grew 2.4% and ex commodities grew by 5.4%. EBITDA pre AASB16 was flat but would have hit our long-term target margins of 27% plus this half had it not been for the negative impact of commodity and Queensland Post Collections. We have maintained discipline and average gate fees at the New Chum landfill in Queensland remains in line with an average of last 18 months. Moving on to the Industrial & Waste Services segment on Slide 12. The Industrial & Waste Services segment provides a wide variety of services with the resources and the infrastructure markets such as drain cleaning, high-pressure cleaning, nondestructive digging and vacuum loading. As you can see, this segment had margin expansion on shrinking revenue. It is on the back of strong focus on good margin contracts and exiting low-margin contracts. We are not interested in poor margin volume for revenue's sake, as it consumes our capital where -- when we can allocate that capital at a much higher return within our own business. While the resource exposed part of this segment is performing well and we are working to improve this business in the infrastructure space, mainly New South Wales and Victoria, to ensure we deliver consistent good growth and a target EBITDA margin of 15%. Now moving on to Liquid Waste & Health Services segment on Slide 13. The Liquids Waste & Health Services segment covers 3 national strategic business units: liquids and technical services, hydrocarbons and health. We are satisfied with the performance of LPS, and we know that it has an improvement journey ahead of it -- it has a significant improvement journey ahead of it. They are in a final phase of ERP-related changes, which will finish the integration activities impacting our employees. This business unit was most impacted by integration. We believe that it's now on the path to a very strong recovery and we remain very confident and with the quality of management running this business unit. Hydrocarbons has continued its good performance, driven by good volumes and production efficiencies following recent plant upgrades. Health has also continued on its good performance journey and is well on track to deliver its long-term strategic expectation. It has resigned most of its major customers for another 3 to 5 years. This segment, which is Liquid Waste & Health Services segment, is on its way to deliver targeted 20% EBITDA margins, and we remain focused and committed to making it happen. I will now pass over to Brendan to run through the underlying adjustment balance sheet, cash flow and debt.

Thanks, Vik. The statutory profit after-tax attributable to ordinary equity holders was $46.2 million. The underlying adjustments to EBIT totaled $39.8 million and comprised EBITDA adjustments of $20 million, plus $19.8 million for the write-off of the Perth MRF. In addition to the MRF write-off of $19.8 million was a favorable EBITDA adjustment of $1.8 million, comprising the partial insurance receivable of $6.7 million less the increased cost of working. I can now advise that all insurers have confirmed indemnity post 31 December; and we, therefore, expect to recognize an additional $14 million in the second half, which would be presented as a favorable underlying adjustment. Next was $7.4 million costs relating to the acquisition of Victorian Resource Recovery business, which includes significant stamp duty on real estate holdings. During the period, we also incurred integration costs of $14.4 million associated with the acquired businesses, together with the acceleration of the final phase of the Toxfree integration. We remain on track to complete our integration of Toxfree by 30th of June 2020 and within the original $35 million integration cost budget, while at the same time, reconfirming the delivery of synergy benefits. Vik will provide an update of our integration progress later in this presentation. In the second half, we expect to recognize approximately $8 million profit as we settle a contracted sale of a closed landfill's buffer land. This profit, together with the additional $14 million from our insurance claim, does not form part of our underlying full year guidance. These are one-off significant transactions that will be presented below the line. To be clear, this expected $22 million profit before tax will not form part of our underlying results and is not included in our full year EBITDA guidance. Turning now to the balance sheet on Slide 15. Our balance sheet remains strong, and we continue to maintain our culture of financial discipline. The new leases accounting standard, AASB16 was applied from 1 July and increased our assets by $278 million and our liabilities by $288 million. Our right-of-use assets presented under the new accounting standard totals $420.6 million and also includes the former finance leases that were previously classified within property, plant and equipment. During the half, our rectification and remediation provisions reduced by just over $13.5 million. This reduction was mainly due to expenditure for the period of $20.4 million, less the unwinding of the discount rate and acquired remediation liabilities. Turning now to the cash flow on Slide 16. As I've stated a number of times previously, we maintain a high level of fiscal discipline at Cleanaway, and our cash flows are consistent with our previously stated commitments. On a pre AASB16 basis, our net cash from operating activities declined by $35.5 million compared to the prior corresponding period. The key driver of the reduction was the one-off $25 million tax refund in August 2018 that was not repeated in this half. Additionally, underlying adjustments increase mainly related to acquisition and integration costs, remediation expenditure increased by $7.8 million to $20.4 million for the half and is well within our announced planned expenditure. Vik will elaborate on our forecast rectification, remediation spending later in his presentation. Capital expenditure for the period was $100.7 million and was well within our planned stated range of approximately 10% of net revenue and below our D&A. Our free cash flow was therefore $28.9 million lower than the prior corresponding period. Two of the major drivers of this reduction are the increased remediation and capital expenditure that I previously referred to, and both were lower than the planned spend rates we're advised at the FY '19 full year results briefing in August. I'm particularly pleased that our cash conversion rate continued to be strong at 97.4%. This result was achieved after absorbing additional receivables from our acquisitions. Turning now to our debt on Slide '17. Our debt is well under control, with a net debt to underlying EBITDA ratio of 1.6x on a pre AASB16 basis. This is a level that provides us the flexibility we need in the future to fund selective earnings creating projects and acquisitions. Our gearing ratio, defined as net debt over net debt plus equity, is currently at a healthy 23% on a pre AASB16 basis. Our average debt maturity at 31 December was 3.4 years. On the 11th of February, we completed a U.S. private placement notes issue. The currency exposure has been hedged, resulting in 3 equal tranches of AUD 133 million, with maturities of 8, 10 and 12 years. The weighted average margin is 1.61% by Australian bank bill swap rates. As a result of the notes issued and the cancellation of a short-term $250 million facility, we have extended the average debt maturity to 5.8 years. I will now hand you back to Vik.

Thank you, Brendan. I'm on Slide 18. Our disciplined approach to allocation of capital has not diminished. The standard capital expenditures spend levels in global waste management companies is usually around 10% of net revenue and this is a level that we believe is sustainable long term. Expect us to be in line with this target. Please note that D&A will change in future... [Technical Difficulty] as a percentage of D&A will be redundant. We will use percentage of net revenue as a metric for cash capital expenditure going forward. Another key component of our free cash flow, electrification and remediation that is detailed on Slide 19. And I'm very pleased to report that [Technical Difficulty] the end of legacy remediation spending that we have experienced over the past 5 years. While spending in FY '20 will be high at circa $55 million due to project timing, the average spend over these 5 years will be just below $45 million per annum. This is in line with the forecast 4 years ago. As we would appreciate in our waste business, ongoing rectification and remediation is of disturbed landfill business of usual activity. So to reconfirm, we will wrap up majority of legacy issue by end of FY '20, spending on legacy and closed landfill reduce quite significantly from FY '21 to approximately $20 million per annum and then post FY '25 to a steady rate of approximately $10 million per annum thereafter. What this means is that the company will generate circa $125 million more cash in the next 5 years compared to the last 5 years, keeping everything same. Needless to say, the sale of remaining closed landfills to interested parties under strict conditions is a live auction. Brendan has just confirmed another contracted sale of a Tullamarine buffer land in Victoria for second half of FY '20. I would now like to move to our Footprint 2025 on Slide 20. Many of you will have seen this slide previously, but I wanted to reiterate that our commitment to the optimization of waste value chain and extracting maximum value from what we call Evolving Tonne has not changed, however. We extended the value chain to include the downstream processes of recovered materials to ensure we retain this value in fast-changing, sustainability-driven world. The footprint 2025 thinking revolves around the creation of a platform of these priced assets. Acquisition of SKM fits into their strategy, so does the plastic pelletization plant we announced today. And work is in progress to develop glass beneficiation in Victoria and possibly a paper pulping plant as well. And by further expanding our network of these assets, we leverage them to serve our existing customers better and win new business. On to Slide 21. Through 2 strategic acquisitions, we have fundamentally changed our footprint and resource recovery capabilities in Victoria and Tassie to create a stronger and more diversified leading business. With the acquisition of SKM, we have become a leader in resource recovery in Victoria processing over 200,000 plus tonnes of co-mingled recycle for some councils. The network of strategically located MRFs and transfer stations provide us with the ability to service councils from Melbourne, Geelong, Mornington Peninsula as well as Tassie. The MRFs are equipped with advanced optical sorters and technology to produce high-quality commodities and the plastic recovery facility in Laverton enables us to sort the mixed plastic into individual polymers to create further value, which will then also be an input into the new pelletization plant. By initially acquiring SKM debt from CBA, we were able to appoint administrators over the business. This awarded onerous council contract and enabled the start of a turnaround. The administrators then launched the sale process, and we were the successful bidder acquiring the asset for $66 million and taking ownership of this business in early November. The turnaround of this business is well progressed, with the sites being cleaned up, and I'll give you an update in next slide. The sale of 2 noncore assets in South Australia, acquired as part of the SKM integration, transaction is well progressed with the sales proceeds expected to be in excess of $6 million in future. We have also acquired a small business called Statewide, which provides us with a strong position in the attractive regional Victorian market, including -- which includes mainly Collections business but also putrescible transfer station in Wunambal and a depot in Hamilton. I ask you to please move to Slide 22. The acquisition of SKM, a fair amount of progress has been made in the turnaround and integration of SKM into Cleanaway. We expect full integration of this business into our Victorian and Tassie business by June 2020. These sites were overflowing with waste, and the first task was to clean them up and remove all stockpiles. Concurrently, we have commenced contraction negotiation with councils. We remain absolutely confident of signing 200,000 plus tonnes as committed at the current gate fees for FY '21. All machines are being checked for safety, liability and engineering improvements. The plastic sorting facility at Laverton is working fine. Talking about plastic, like you to turn to Slide 23. As for our extended value chain strategy, I'm pleased to confirm that we have signed a partnership with Pact Group and Asahi Group to construct Australia's largest plastic pelletizing plant. While the scale is important, what is more critical is the nature of the partnership. It is the first example in Australia where a waste management company has partners with the specialist manufactures and end user for a complete closed loop, mitigating significantly risk of offtake. We always said China National Sword was a challenge in the short-term but offered significant opportunities to scale players and access to commodity in future will become a strength, not a weakness. The plant capacity will be 28,000 tonnes, which is equivalent to approximately 900 million plastic bottles. And I think it is worthwhile appreciating the concept. The offtake can also go to our Cleanaway Daniels manufacturing plant in Sydney. You would remember that we brought in-house the manufacturing of our Daniels branded products from China for IP protection and to consolidate with our personal shaft container business in Western Sydney. The site selected for plastic pelletizing is Albury-Wodonga and is expected to service all of East Coast of Australia. Our aim is to get it running by end FY '21. Moving on to further progress on Footprint '21 Strategy (sic) Footprint 2025 Strategy on Slide 24. In October, we announced our plans to develop an energy from waste facility in Western Sydney and the acquisition of site in Eastern Creek. The announcement followed a very detailed multi-criteria assessment to find the optimum site and months of confidential consultation with various stakeholders, including the Department of Planning, Industry and Environment and the EPA. The plant facility will be able to process 500,000 tonnes of residual waste that cannot be recycled and turn this into power for as much as 65,000 homes. This represents less than 1/3 of 1.6 million tonnes currently in Central landfill from Western Sydney. It will enable us to internalize our own food waste from our C&I business and offer a landfill divergence solution to local councils. We will invest in advanced European technology, which is proven to be safe and will meet all European emission standards, which are most stringent in the world. The application process is now under way. And in December, we received the Secretary's environmental assessment requirements from the Department of Planning, Industry and Environment, which sets out the topics that will need to be addressed in the environmental impact statement. We are in a process of preparing our EIS and expect to submit this by May-June 2020, with the aim to receive final approval something -- sometime during 2021. In parallel, we continue engagement and a significant engagement with local community councils, government and other stakeholders in relation to the project. We are encouraged by the overwhelming positive reactions today but are conscious of the need to continue to build a very strong social license to operate. Moving on to Slide 25. You have seen this slide before. This is about our Toxfree integration. I can tell you the integration of business is well under way. We are on track to deliver $35 million in expected synergies and all integration activities costs and benefits will be wrapped up by June 2020. On Slide 26, we have now finalized the enterprise operating model, the alignment of strategic business units to waste stream, service offering and assets is complete, brand and price harmonization has been done, branding on mobile assets has commenced with the aim of finishing by June 2020, which we will. On go-to-market, rate cuts have been harmonized across the business, and we are getting our sales process and market segmentation 100% aligned. In property and infrastructure, we have amalgamated and closed several sites and the upgrade of other priced assets still well under way. On Slide 27, we are putting increased efforts into building capabilities, enabling and compliance of procurement initiatives. Needless to say, we cannot integrate multiple companies without common process and system, which provides clarity and agility. I want -- I'm very pleased to confirm to all of you today that we have hit a major milestone successfully on ERP convergence between Toxfree and Cleanaway in February. This was a massive task for the organization. And I think management and team has done a very good job. As I've stated previously, the work that we are doing on expansion of the $35 million synergies, which will be delivered by June 2020. Moving on to our last slide, Slide 28, before we open for questions. Our Slide 28, our priorities for the second half are pretty self-explanatory. Safety, customer and growth remains our #1 priorities across all 3 segments and across the enterprise. We expect volatility on commodity prices to remain and hence focus is on aligning pricing, rebid mechanism with market conditions. As I said before, long term, we see commodity pricing ownership as a strength and a leverage and a possibly competitive advantage. We expect better volumes while holding price in our Queensland landfill and as I confirmed to you before, we will hold pricing and our average gate fees has remained same as past 18 months. Aim to get a run rate in Liquids & Health segment to target margin levels, continue return on our IWS segment, finish stock screen SKM integration by June 2020. And finally, on our outlook for FY '20 in light of AASB16 and moving -- and all the other moving parts we have decided to provide guidance for FY '20. We expect the company to deliver earnings growth in second half '20 above first half '20 and second half '19. We are targeting underlying EBITDA of $515 million to $525 million post AASB16 for the full year results includes $43 million to $45 million positive impact from AASB16 and I reiterate again what Brendan said before, the $22 million benefit from insurance as well as sale of Tullamarine land is not included in this guidance. Now in light of our teleconference rather than operator run call, can I please suggest rather than everybody [ trying ], I'll just call the name of the analyst, if that's okay. And then we run a sequence of asking questions, okay? I'll open the line for questions.

As I'm going to name out the analyst number one. Pete Steyn from Macquarie. Pete, do you have a question. [Technical Difficulty]

Vik, I do. [Technical Difficulty]