2023-08-14 19:08:36 ET
Summary
- CWST provides solid waste services in the United States.
- Despite lower-than-expected revenue, CWST's segments show strong performance and a solid business model.
- The recent drop in share price presents a buying opportunity, with management increasing revenue growth forecast and guidance.
Summary
This post is to provide my thoughts on the Casella Waste Systems ( CWST ) business and stock. CWST provides integrated and non-hazardous solid waste services throughout the Eastern United States. I am recommending a buy rating for CWST as the underlying fundamentals are very sound and strong. The reported headline numbers have resulted in a poor share price reaction, which I view as a buying opportunity.
Investment thesis
CWST's revenue for the second quarter of FY23 was $290 million, which is about 3% lower than the consensus estimate of $302 million. Acquisitions accounted for 1.8% of the quarter's revenue growth, while the remaining came from increases in collection and disposal pricing, sustainability fees, and other sources, partially offsetting the negative effects of lower commodity prices (CWST is exposed to recycles commodity prices as they recycle collected waste, the higher the commodity prices, the better) and solid waste volumes. Performance looks bad on the surface, but a closer look at the segments indicates that CWST is still in good shape. CWST's solid waste operation increased by 8% y/y to $218 million, primarily due to Collection's 9% growth to $149.8 million. However, CWST's inability to influence the decline in commodity prices was a major contributor to the poor performance of the Resource solutions segment.
Another indicator that CWST's business model is solid is its price/volume relationship. Price increases of 8.2% for collections and 7.1% for disposal contributed to an overall price increase of 7.7%. Since CWST pricing model is at a percentage above inflation, I believe prices will stay at the current high level given the inflationary environment. Taking into account the US inflation rate as well as past price fluctuations, I anticipate that 2H23 prices will be higher by more than 5%. On volume, it saw a decline of 2.6%. I applaud management for being truthful and straight forward to their explanation that lower volume across almost all of their specialty waste categories was a primary contributor to the weaker-than-expected volume. However, I don't think the situation is as dire as it may seem. While clients' caution in the face of macro uncertainty dampened industrial volume, I anticipate this will strengthen as the economy strengthens. I also think that the business will be in a better position to generate higher-quality revenue and profitability in the future as a result of management's decision to renegotiate unprofitable contracts.
There's a handful of them out there and there's a couple of notable ones in Connecticut. There's a few notable ones around our Western Mass recycling facility as well. And there are a couple of million dollars a year of negative headwind and we -- very successfully over the last decade have worked with communities and different businesses to share that risk more effectively. And we don't have an expectation that we can't do the same thing here over time. 2Q23 earnings results call
Yes. I know really related, as you know, I think Tyler, two acquisitions, those contracts all came with acquisitions and we'll renegotiate them at the end of the contract obviously. 2Q23 earnings results call
With the completion of their investment in their Boston MRF facility, CWST should also see a structural improvement in their overall volume capacity going forward. Back in May 2023, during the Oppenheimer 18 th Annual Industrial Growth Conference , management mentioned that increased in capacity will be in the range of 30 to 40%, so I think this bodes well for volume growth.
In my opinion, the recent drop in share price is an excellent buying opportunity, as it was most likely caused by a disappointing headline. Management appears to share my optimism, as they have increased their revenue growth forecast for FY23 to 8% at the midpoint. After completing the acquisition of GFL's assets, management is optimistic that the company will be able to generate stronger revenues and continue to execute well in its solid waste business. To begin, CWST and GFL reached an CWST)%2C%20a,Maryland%20from%20GFL%20Environmental%20Inc." target="_blank"> agreement a few months ago for CWST to acquire GFL's assets in the states of Pennsylvania, Delaware, and Maryland. Management expects $185 million in revenue and $43 million in EBITDA in the first year following the acquisition. As the Twin Bridges purchase is not accounted for in the guidance, it is possible that it is conservative.
Valuation
I believe the fair value for CWST based on my DCF model is $98.46. My model assumptions are that FCF can grow at 15% during the growth years (FY23 will follow consensus expectations), followed by a deceleration to 5% in the terminal year. The reason I used 5% is because CWST pricing formula tends to be above inflation at a certain % (Assuming a 2% long-term inflation rate). Also, I see CWST as a very stable and inflation pegged business, hence, I used at 8% discount rate. To sense check my price target, I note that CWST was trading at $95 just a few weeks ago, so this is not a far-fetched price target.
Risk
A short-term risk for CWST is the continuous fall of commodity prices that CWST is exposed to. As we have seen in this quarter, weak commodity prices certainly can impact performance on a headline basis. If commodity prices were to fall further, it could lead to poor stock sentiment in the near-term.
Conclusion
In conclusion, despite CWST recent disappointing headline results, the underlying fundamentals of the business remain robust and promising. While the reported numbers led to a decline in share price, I believe this presents a favorable buying opportunity for investors.
For further details see:
Casella Waste Systems: Headline 2Q23 Results Poor But Fundamentals Remain Sound