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Looks a great record. In fact, in terms of revenues, it looks far too great. Of course, acquisitions have played their part. But more on those later. Margins have deteriorated noticeably, although they are still very impressive, holding up above the 20% level.
So, is this a business I understand, and has predictable earnings? Waste Recycling, as the name rather obviously states, basically takes care of rubbish. The company undertakes the "management" of waste for local authority and commercial customers, mostly around Northern England.
The storming group revenue growth record has been aided by acquisitions. Stripping out the purchases gives a disappointing picture.
After the acquisition spree, calculating return on equity figures is not straightforward. Again, I've had to make a few adjustments to the figures, to keep things simple. Specifically, I've roughly annualised the post-tax profits for 1997 and 1999, and I've taken just the year end equity figures with goodwill written off added back, rather than an average. The final return on adjusted equity gives a good handle on performance.
I'm not at all impressed with these low figures. The acquisitions of last year may still have to "bed in", with the full impact of profitability from the acquisitions yet to filter through into my calculations. But Waste Recycling states that the two purchases are complete and have had a successful reorganisation. So I'm not expecting any drastic readjustments to the 1999 calculation, as and when the picture becomes clearer.
Looking at the cash flow characteristics, I'm certainly not getting the same warm feeling as I did with Southnews (LSE: SNW). Large chunks of operating profit are expensed as capital expenditure. Another worrying sign is the deterioration in the movement of working capital. Up to and including 1997, one very positive aspect of Waste Recycling was that it was able to spit out cash in terms of working capital. This situation has dramatically reversed, with large amounts of cash now tied up in the debtor ledger. Quite concerning. Overall, I think I can say that Waste Recycling does not understate its accounting profits.
As a business, I like Waste Recycling. It's dull, boring and predictable, and provides an essential service. The company comments today that "the opportunities that the future holds for progressive waste management companies have never been better." Indeed, even after all of the acquisitions, Waste Recycling still only has about a 7-8% share of the UK waste market. There are plenty of avenues of material sales growth, but it seems to me that it will mostly come from acquisitions. Certainly the rather static underlying sales growth of the last two years gives that impression. Does this situation seem familiar? Who said Rentokil Initial (LSE: RTO)?
Firstly, the financial record.
To 31st December 1995 1996 1997 1998 1999
Sales (£m) 9.6 15.4 27.2 45.9 139.3
Operating Profit (£m) 3.4 4.6 6.8 11.3 30.0
Earnings per share (p) 6.7 8.1 10.9 13.8 17.3
Operating Margin (%) 35.4 29.9 25.0 24.6 21.4
Sales Growth (%) 60.4 76.6 68.8 203.5
Earnings Growth (%) 20.9 34.6 26.6 25.3
The Waste Recycling Business
Put simply, rather than the customers dumping their rubbish in the nearest river, Waste Recycling takes it away, recycle some of it should the customer require, and dumps the rest into one of its landfills. Waste Recycling also provides treatment services for any hazardous materials, and has also embarked on a venture to generate electricity from the methane gas emanating from the landfill sites.
The company also owns a few quarries. The reasoning for this is that the company can be paid two ways -- to create the landfill by selling the quarried stone, and to fill it back up again with rubbish.
Although I admit not knowing the full ins-and-outs of the industry, having lived less than half a mile from a landfill site for many years, I think I have a pretty good grasp of what actually goes on. And how busy a landfill site can be.
And predictable earnings? Waste Recycling has 55% of its revenues from long-term contracts. Indeed, the group announced in September a 25-year contract for the disposal of waste produced in Hull. Not only does the company benefit from this "earnings visibility" through the benefit of long-term contracts, the necessity of waste disposal itself doesn't make for a company too dependent on the economic cycle. Even in a deep recession, local authorities will still want their waste removing. A recession may lead to a reduction in the volume of industrial waste to be treated, but I can't really see a downturn in the economy having a material effect on Waste Recycling. All in all, I think Waste Recycling has about as predictable earnings as you can get.
Having 20% margins does indicate some sort of "franchise" attribute to the business. Barriers to entry within the landfill business, I assume, are quite high. You can't just set up your tip overnight. Planning restrictions help the existing players to carve up any new business between them. And needless to say, the business of waste disposal is not going to be usurped by an upstart cyber-venture anytime soon. Although having said that, competition for Waste Recycling does exist, the company commenting today that long-term contracts had been won against "stiff" competition. Can Waste Recycling differentiate itself from the competition, or is handling rubbish treated as a commodity service by the customers?
Recent Acquisitions
During 1997, Waste Recycling made two acquisitions. Darrington Quarries generated £9m of revenues in the seven months prior to purchase. East Waste generated £2m in the four months prior to acquisition. Assuming no seasonality in these businesses, total annualised revenues of £21.4m can be assumed.
So, adding on the £21.4m to the continuing sales generated in 1997, £23.5m, gives a total of £44.9m -- the benchmark revenue level for the next year (1998). And the actual revenues for 1998 (thankfully an acquisition-free year)? Just £45.8m. Uh-oh, anaemic sales growth alert!
And so on to 1999. Waste Recycling dramatically enlarged its business early last year, through a "merger" with Yorkshire Environmental Global Waste Management, previously owned by Kelda Group (LSE: KEL), then acquiring 3C Waste. All the corporate activity effectively tripled the size of the underlying Waste Recycling business. Both new additions brought £93.4m to total turnover in 1999.
So, what of the revenues for 1999, excluding the two new enterprises brought on board? Er, £45.6m, the same as the year before. Chairman David Williams comments in the results announcement today: "The timing of the acquisitions has complicated the results for the year making comparison with the previous year difficult." Really?
Overall, I'm not getting an overwhelming feel for any organic growth here, certainly not in the last two years. I suspect acquisitions are the name of the game in this industry, described by the company today as "rapidly consolidating".
Other Financial Measures
To 31st December 1997 1998 1999
Total annualised
post-tax profit (£m) 6.97* 6.85 20.7*
Shareholders'
funds adjusted for
goodwill (£m) 60.41 66.97 338.68
Return on
adjusted equity (%) 11.5 10.2 6.1
(* adjusted to include estimated annualised profits from acquisitions)
But maybe Waste Recycling is a supreme cash generator, and the accounting profits are understated?
To 31st December 1996 1997 1998 1999
Operating profit (£m) 4.63 6.77 11.63 30.05
Capital expenditure (£m) (4.94) (4.24) (9.48) (34.07)
Change in Working
capital (£m) 0.79 2.46 (3.17) (6.96)
In Summary
Waste Recycling remarks today that the long-term contracts for essential services, with substantial assets in the form of its landfill sites, underpin the long-term value of the group. This value "will be recognised more clearly in the future".
But the trouble for the investor looking at Waste Recycling now is that there has been a significant deterioration in margins, working capital and very importantly, return on equity. Apart from the chunky operating margins, I just can't get financially excited about Waste Recycling. The meagre return on equity, impacted heavily by acquisitions and large capital expenditures, and the static organic revenues, just tell me to stay away.
Your comments on this feature are welcome and can be directed to the Qualiport discussion board.
Related Links
• Waste Recycling website
Note
The Qualiport was launched on December 19th 1997 with an initial investment of £4040.63, all in Rentokil Initial. Further cash was added as holdings in Emap, Marks & Spencer and Unilever were bought during 1998. The vagaries of the value per share accounting method caused percentage return calculations for calendar 1998 to be somewhat distorted. To avoid confusion and somewhat misleading figures, the Qualiport's returns are being measured from 1/1/99, at which point the total portfolio value, including cash, stood at £16,809.60. An additional £2000 cash is added to the portfolio on April 1st and October 1st each year. The total cash investment in the portfolio to date has been £20,184.62. To access the Qualiport's total trade history, click here.