2023-05-12 10:45:28 ET
Summary
- CWST has demonstrated solid performance, exceeding expectations in terms of revenue and gross margin in the recent 1Q23 results.
- Despite a slight drop in EBITDA margin due to temporary headwinds, I anticipate a return to normalized margin expansion as these factors subside.
- CWST's acquisition of GFL's assets is a strategic move that enlarges its TAM and brings a desirable business mix.
Thesis
Casella Waste Systems ( CWST ) provides integrated and non-hazardous solid waste services throughout the Eastern United States. To give context regarding the industry, there are not many publicly listed waste management players in the world, and especially ones with the smaller size of CWST - that have not yet been consolidated by larger players. To put things into perspective, CWST's market cap is ~$5 billion while Waste Management ( WM ) is at $70 billion. My favorite part of CWST is that it is a very attractive target for larger players to acquire. Its geographical presence has huge overlaps with the big boys in the industry. The business also has a pretty solid balance sheet with modestly lower leverage ratio than the big boys. Recent 1Q23 results were also encouraging, exceeding expectations in terms of adj EBITDA on the strength of increased revenue and enhanced gross margin. Management has reaffirmed their guidance for FY23, indicating that things are going well under the surface. Overall, I think pricing can stay strong, and margins can grow thanks to improved operating leverage and scale (as the business expands), as such, I am recommending to buy the stock. Downside should also be supported by a possible takeover from the bigger players.
1Q23 Highlights
The Solid Waste segment continues to perform well, with robust pricing reaching 8.8%. Moreover, revenue exceeded estimates, reaching $262.6 million compared to the estimated $250.5 million. Both gross margin and EBITDA margin also came in better than expected. However, the actual increase in the volume of garbage generated was only 0.3%, which was a bit disappointing but not a red flag. Additionally, SG&A as a percentage of sales came in higher than projected at 14.7%, which was a headwind to the P&L. While the recycling environment remains challenging, it is encouraging to see signs of improvement vs last quarter, with a 20% increase from December through March. Lastly, although inflation levels remain elevated compared to historical norms, they have decreased from their peak.
Pricing
The pricing power of a waste management business is its greatest asset because, in most areas, only one company handles trash collection. As a result, businesses in the sector typically have considerable pricing power, particularly in terms of passing through inflationary price increases without much of a backlash. In 1Q23, solid waste prices increased by an impressive 8.8%. However, I would note not to extrapolate this pricing power linearly over the next few years, as this should be an outlier increase. Historically, 75%-80% of CWST's annual price increases have been implemented in the first six weeks of the year; as such, in order to combat the hot inflationary environment, CWST decided to be more aggressive than usual with pricing (in case inflation goes way above expectation, in which CWST will not be able to increase prices again). The company also benefited from surcharges totaling 6.3%, as the effects of higher fuel prices and commodity price volatility were partially mitigated by the SRA fee. As a result, I anticipate a slowing in price growth over the course of the year.
EBITDA Margin
The ability to raise prices substantially results in a rise in EBITDA. The company's EBITDA increased by 11% to $50.7 million, despite a slight drop in margin to 19.3% due to headwinds that should eventually subside. For instance, the closing of the Boston MRF, acquisition headwinds, and falling commodity prices. Once they leave the profit and loss statement, all of these will become positive factors. Regarding the shutdown of the Boston MRF (Material Recovery Facility), I anticipate that the negative impact will primarily be limited to the first quarter. This is because the company is nearing completion of their technology investments, which they are confident will enhance productivity at the facility. As inflation cools, I also anticipate a return to a normalized pace of margin expansion, and it is good to see that internal inflation is decreasing and has fallen from its peak of 5.9%.
GFL Acquisition
In my opinion, the purchase of GFL is a good one for the company because it will enlarge its TAM and bring in a more desirable business mix, with less C&D risk included (target asset also has little C&D exposure). On April 21st, 2023, CWST and GFL reached an agreement for the purchase of GFL's assets in Pennsylvania, Delaware, and Maryland. In the first year after the acquisition, management estimates it will bring in $185 million in revenue and generate $43 million in EBITDA. It is anticipated that $8 million in synergies will be realized within the first three years of the agreement. What I find most intriguing is that the acquisition may save the company over $130 million in cash taxes over a number of years, as predicted by the management. Aside from the obvious synergies, I think this is good for CWST as a whole because the acquired business is a nice blend of subscription residential and small can commercial and industrial work.
Conclusion
CWST presents an attractive investment opportunity in the waste management industry. With its solid balance sheet and geographical presence that aligns with industry leaders, CWST is an appealing target for acquisition by larger players. Fundamentally, the business is also executing well with recent 1Q23 results exceeding expectations, demonstrating increased revenue, enhanced gross margin, and reaffirmed guidance for the fiscal year. While the volume of garbage generated and SG&A as a percentage of sales were slightly disappointing, the recycling environment showed signs of improvement. Additionally, the acquisition of GFL is expected to bring significant revenue and synergies to CWST, further enhancing its position in the industry.
For further details see:
Casella Waste Systems: Solid Performance With Latest Acquisition Being Value Accretive