RSG - Casella Waste Systems: Too Expensive At This Time (Rating Downgrade)

2023-11-06 14:02:30 ET

Summary

• Casella Waste Systems, Inc., a company specializing in solid waste services, has been downgraded to a "sell" due to its underperformance in the market.
• While the company has experienced growth in revenue, its profits have declined, leading to a decrease in earnings per share.
• The relative valuation of Casella Waste Systems compared to similar companies and its declining net profits suggest better investment opportunities elsewhere.

Whether you love it or hate it, the modern era produces a tremendous amount of waste. I'm not just talking about things like wasted time. Rather, I'm talking about physical waste. This includes trash, biological waste, and more. There is some good news from this, however. And that is the fact that the sheer amount of waste necessitates the creation of companies dedicated to taking care of it.

One of the firms in this market that specializes in providing a wide array of solid waste services operations, is a company called Casella Waste Systems, Inc. ( CWST ). Earlier this year, I ended up analyzing this company and ultimately rated it a "hold." That assessment was based on the attractive growth that the company had experienced up to that point, even though that growth had failed to ensure that the company was keeping up with the broader market. The only major negative in my view at the time was how pricey shares were. And that is why I ultimately did not rate it something more bullish.

Fast-forward to today, and things have not gone exactly as I would have hoped. While the S&P 500 (SP500) is up 9.4% since the publication of that article back in March, shares of Casella Waste Systems have seen downside of 0.9%. Looking back at the company now, I do still believe that the long-term outlook for shareholders is positive. But when you really take a step back and think about the expense side of the equation, it becomes clear to me why the stock has pulled back a bit.

This reassessment of the firm has led me to conclude that perhaps I assigned too much value to the quality and growth of the operation and too little to how much investors were paying for those things. To rectify that situation, I have decided to downgrade the company to a ‘sell’ to reflect my new view that the stock is likely to underperform the broader market for the foreseeable future.

When quality costs too much

When evaluating Casella Waste Systems, it might be helpful to look at the most recent financial performance reported by management. That would be data covering the third quarter of the company's 2023 fiscal year that management just reported on November 1st. During that time, sales came in at $352.7 million. That represents a massive 19.4% increase over the $295.3 million generated one year earlier. One of the contributors to this increase was a rise in solid waste pricing. This was up 6.9% year over year, largely as a result of a 7.6% rise in collection pricing and a 5.9% increase associated with disposal pricing.

Interestingly, solid waste volumes were actually down year-over-year because of lower project based special waste volumes at the company's landfills and because of strategic decisions made aimed at improving margins when it comes to the residential line of its operations. Most of the growth in revenue, then, came from acquisitions that the company completed. In the first nine months of the 2023 fiscal year, management allocated $847.8 million toward acquiring other companies. It is worth noting that, even though revenue did increase nicely year-over-year, sales for the quarter actually came in $8 million lower than what analysts had forecasted .

The rise in revenue did not, unfortunately, result in higher profits. Net income actually shrank from $22.7 million last year to $18.2 million this year. There were multiple contributors on this front. For instance, interest expense nearly doubled from $6 million to $10.2 million. Costs associated with acquisition activities, meanwhile, jumped from only $0.8 million to $3.3 million. The decline in profits resulted in earnings per share falling from $0.44 to $0.31. Although earnings did fall short of what the company achieved last year, they did manage to come in $0.07 per share higher than what analysts anticipated. Other profitability metrics for the firm were far better by comparison. Operating cash flow, for instance, went from $60.1 million to $74.6 million. If we adjust for changes in working capital, we get an increase from $69.7 million to $79.4 million. And finally, EBITDA for the company grew from $75 million to $89.6 million.

As you can see in the chart above, financial performance for the first nine months of the 2023 fiscal year were very similar to the third quarter on its own. Revenue increased while profits declined. And without exception, the cash flow metrics of the company grew. But management did have an interesting take on matters. The reason why shares of the enterprise rose over 7% after news broke regarding earnings is because of an increase in guidance for the year.

Previously, it was expected that revenue would be between $1.24 billion and $1.265 billion. That number has now been increased to between $1.255 billion and $1.28 billion. Net income should now be between $33 million and $39 million, which would actually be down from the prior expected range of between $41 million and $47 million. But EBITDA has been increased to between $292 million and $298 million, while prior guidance provided by management had called for it to be between $289 million and $295 million. Lastly, operating cash flow guidance remained unchanged at between $231 million and $237 million.

Using these estimates provided by management, I then priced the company in the chart above. I also priced it using data from 2022. Shares look fairly expansive, but not necessarily overvalued on an absolute basis. But as part of my analysis, I then compared the firm to five similar companies as shown in the table below. On a price to operating cash flow basis, Casella Waste Systems ended up being the most expensive of the group. And when it comes to the EV to EBITDA approach, four of the five enterprises are more expensive than it.

Takeaway

Given the relative valuation of Casella Waste Systems and its decline in net profits year-over-year, and even in spite of improved guidance for revenue and cash flows, I do think that a more bearish assessment of the company is in order. In the long run, the company will continue to grow. In fact, even after the quarter ended, management made another purchase for $219 million that should add $70 million in annualized revenue for shareholders. But in this market, when there are other prospects that can be had at significant discounts relative to this, and when you factor in the other weaknesses that I pointed out, such as declining profits and contracting volumes, I do think there are better opportunities for investors to consider. And for these reasons, I would argue that a soft "sell" rating is appropriate for Casella Waste Systems, Inc. at this time.

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