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True believers in clean-technology companies are having their faith repaid. After badly underperforming the sharemarket for years, cleantech stocks have rallied.
The Australian CleanTech Index, a key barometer of ASX-listed cleantech stocks, rose 13.1% in FY17. The S&P/ASX 200 index gained 9.4% (excluding dividends). Waste stocks, in particular, have been strong this year and some still look attractive.
The Australian CleanTech Index’s cumulative gain over three years to FY17 is 60%. The ASX 200 rose 6% over three years as the market broadly tracked sideways.
Qualification is needed with cleantech gains. The performance of a handful of billion-dollar cleantech stocks influences the capitalisation-weighted Australian CleanTech Index. Sims Metal Management’s (SGM) rally since early 2016 has been a big contributor to index gains.
Also, cleantech is a loosely defined part of the market compared to other sectors. There is no official listed “cleantech” sector in Australia. The CleanTech Index, for example, includes several lithium explorers that ASX classifies in the mining sector.
The Australian CleanTech Index is based on 65 companies with a combined market capitalisation of $33 billion. Largest members are Meridan Energy (MEZ), Mercury NZ (MCY), Reece Australia Holdings (REH) (green buildings), Contact Energy (CEN), Sims Metal Management, Cleanaway Waste (CWY) (formerly Transpacific Industries) and Reliance Worldwide Corp (RWC).
Caveats aside, many cleantech stocks delivered stellar gains in FY17. Sims, Cleanaway and Genex Energy (GNX) gained more than 30% in FY17.
Waste was the standout sub-sector in the Australian CleanTech index. Its 68% gain in FY17, thanks largely to Sims Metals, dwarfed gains in the water sub-sector index, renewable energy index and efficiency and storage index.
I have long advocated waste as the best way to play cleantech stocks. Waste is by no means the most glamorous or high-tech part of the cleantech sector. But waste services are more recession proof and waste companies, unlike many cleantech firms, are profitable and less speculative than most of their cleantech peers.
The waste industry remains fragmented with a handful of firms dominating. Population growth, infrastructure developments and greater corporate focus on collection of waste, including hazardous materials, should support steady growth for the industry.
Waste management is all about scale. Smaller operators struggle to compete with firms that have large landfill networks. High fixed costs of landfill sites and regulatory hurdles create barriers to entry in waste management and some pricing power for incumbent firms.
Here is snapshot of the three largest waste management stocks:
Sims has a one-year total return (including dividends) of 95%. The company has benefited from higher scrap-metal prices, improving United States steel demand and management initiatives to streamline the business and position it for growth.
I nominated Sims as one of five stocks to sell for the Switzer Super Report in January, when it traded at $12.35. After slumping to $11 in early February, Sims has rallied to $15.54.
The company in June announced that internal initiatives would deliver an extra $70-$95 million in annual savings when complete – news that reignited the share-price rally.
Sims management is doing a good job to cut costs and maintain volume capacity, amid a supportive trading environment for scrap metal. Subdued Chinese export activity in scrap metal and continuing solid prices are favourable tailwinds.
But Sims is trading well past the average price target of $13.31, from a consensus of 10 broking analysts. An estimated forward Price Earnings (PE) ratio of 20 is high for a business that has no discernible competitive advantage and is a price taker in a commoditised market.
There’s a lot to like about Sims’ performance and I acknowledge it has done better than I expected this year. But some profit-taking is warranted.
Cleanaway has rallied over one year with a 57% total return. The company is Australia’s waste management leader with an estimated 20% market share.
Cleanaway announced a better-than-expected FY17 interim result in February. Underlying after-tax net profit rose 20.3% to $34.9 million. Strong growth in cash flow, expanding profit margins and declining debt-to-equity were other highlights.
Like Sims, Cleanaway is benefiting from management initiatives to boost efficiencies. Longer-term, Cleanaway’s strategy to extract maximum value through its supply chain, from waste collection to resource recovery and landfill, makes sense.
Cleanaway has good potential. The company serves more than 2 million residences each week and over 100,000 commercial and industrial customers. It continues to recover more resources from waste (such as renewable energy) and is increasing its landfill network.
The challenge is valuation. At $1.31, Cleanaway trades on a forecast FY18 PE of about 25 times, according to Morningstar. That’s too high for a business that has had a low single-digit Return on Equity, including several years of negative ROE, over a decade.
Supporters will argue Cleanaway is starting to realise its potential and is on track to lift the ROE. The stock would look more interesting around $1.10.
Bingo is an interesting newcomer in the listed waste management and recycling space. The company joined ASX in May 2017 after raising $440 million in a difficult Initial Public Offering (IPO) market. Bingo’s $1.80 issued shares are $1.98.
The $685-million company operates mostly in New South Wales through nine resource-recovery and recycling centres. A fleet of 158 vehicles collects 17,800 bins across a range of purposes. Bingo is particularly strong in building and demolition waste collection.
NSW is Australia’s most attractive waste management market. Expected population growth of 1.6 million by 2031 in Sydney and strong infrastructure construction should offset slowing residential construction, thus underpinning waste-services demand.
Bingo is expanding rapidly through organic growth and acquisitions. The company forecast in its prospectus a compound annual growth rate (CAGR) of 50% in underlying earnings (EBITDA) over FY15 to FY18. Exceptional revenue growth in its recycling operations, as new or upgraded facilities come on stream, are underpinning gains.
Some brokers estimate Bingo will achieve a Return on Equity above 25% in FY17 –high for a company operating in a competitive, commoditised industry.
Bingo forecasts after-tax net profit of $40.7 million for FY18. At $1.98, that puts it on an indicative PE of about 17 times. Most of Bingo’s closest Australian and international waste management peers are on PEs in the high teens or mid-twenties.
As mentioned earlier, Cleanaway is on a forecast PE of 25 and the well-run Tox Free Solutions, a Perth-based waste management company, is on a PE of 18 times, on Morningstar numbers. A consensus of eight broker forecasts suggests Tox is fairly valued.
Bingo should trade at a discount to its larger peers given its limited history as a listed company. But the current size of the discount is too large.
Share-valuation service Skaffold values the company at $2.20 in 2018 and $2.77 in 2019. Macquarie Group, lead manager to the Bingo float, has a 12-month target of $2.33. That suggests reasonable gains from the current price; earnings risks are on the upside given Bingo’s growth rate and potential to beat market expectation.
Like all small-cap IPOs, Bingo suits experienced investors who are comfortable with higher-risk stocks. The company is well run and its founder, the Tartak family, have kept a 30% stake in a business they developed over 12 years.
I always keep a close watch on family-owned companies that build assets up over years, raise capital via an IPO and retain a strong financial interest. Such IPOs often have a lot more substance and a realistic valuation than those vended by private-equity firms that look for a quick exit when investors are prepared to pay over the odds.
On balance, Bingo is a cheaper way to play the waste management theme, has potential for faster growth than its larger peers and looks the pick of its sector at current prices, albeit with higher risk.