FY19 was a mixed year for Renewi PLC (LON:RWI), (BS:RWIl) with variable portfolio performances and two particular external challenges faced (at ATM and Derby). Despite this, the company still delivered profitability in line with the prior year. Net debt reduction and operational improvements will be key focus areas for FY20 and beyond and these remain key near-term sentiment drivers in our view. The share price has started to recover over the last couple of months although the rating suggests this has further to go.
Business description
Renewi is a waste-to-product company with operations primarily in the Netherlands, Belgium and the UK and was formed from the merger between Shanks Group and Van Gansewinkel Group in 2017. Its activities span the collection, processing and resale of industrial, hazardous and municipal waste.
Profitability maintained in mixed-business trading
FY19 results slightly exceeded revised guidance at the year end and included good progress in the Commercial Waste division following flagged Q4 momentum. PBT was flat year on year, reflecting mixed trading in other divisions, most notably constrained soil remediation activity at ATM due to industry permitting issues. Excluding the amortisation of acquired intangibles, non-trading/exceptional items totalled c €145m, the largest elements of which related to post merger synergy/integration actions (c €57m), the delayed Derby UK Municipal facility (c €64m, substantially non-cash) and pre-disposal goodwill write-downs. Net debt ended FY19 at €556m (or €552m in ongoing operations) equivalent to just over 3x EBITDA in the year. The reduced dividend payout was in line with previous guidance.
Earnings estimates maintained, strategy refreshed
Our PBT estimates are unchanged and point to lower group earnings in FY20 before recovering strongly thereafter, with ATM modelled to return to meaningful profitability on the assumption the permitting issues are resolved. New CEO Otto de Bont has presented a refreshed business case highlighting Renewi’s strong positions in leading European circular economies where the regulatory onus is on producing higher-quality, higher-value secondary materials enabling the delivery of growth and a strengthening competitive position in relatively low-volume growth markets. At the same time, the company will be pursuing only waste-to-product activities and aims to simplify and lower the cost to serve.
Valuation: Corporate actions to be next catalyst
Since our year-end update note, Renewi’s share price has picked up a further c 9% and is now in positive territory for the year to date (marginally underperforming the FTSE All Share Index). On unchanged earnings estimates, the company’s rating is now a P/E of 8.8x, EV/EBITDA (adjusted for pensions cash) of 5.4x and a prospective dividend yield of 4.1% for FY20. As before, we believe that disposals and/or ATM coming fully back on stream would have positive implications for group net debt and the company’s share price.
FY19 results overview
Renewi’s largest division performed well and offset weakness elsewhere – most notably at ATM – to maintain group PBT at prior-year levels. Exceptional charges (including greater clarity regarding the new Derby Municipal facility) caught the eye but progress at Commercial Waste is a key message in the continuing businesses in our view. Core ongoing net debt was up slightly more than we had anticipated but not materially so and ended the year at just over 3x FY19 EBITDA. Dividends were in line with revised guidance and our headline PBT estimates are unchanged.
As we commented at the interim stage, divisional business models vary. We have updated the table shown to incorporate full-year data and show relatively low H1/H2 seasonality in Exhibit 2. Notwithstanding weaker second half trading periods in Monostreams and UK Municipal in FY19, we are struck by the strong comparability/low-level variation between the numbers presented below and their FY18 equivalents in core revenue streams. We believe this demonstrates significant business model stability, which suggests that ingrained operational improvements can lead to sustained uplifts in profitability. This is not to deny the short-term impacts that occur from pricing variations (eg in recyclates or incinerator costs) but is a reference to potential medium- and longer-term trends.
Commercial Waste: good momentum visible at the end of FY19
Headline growth rates of 3% and 18% for divisional revenue and EBIT respectively clearly indicate the benefit of post Shanks/VGG merger synergies continuing to come through. The incremental uplift was €9.9m, which is slightly more than the €9.2m reported EBIT increase. In the face of both rising incinerator costs and lower recyclate income during the year, we consider the substantial retention of synergy gains to be a very creditable result. Collection route consolidation was completed in Belgium in H1 and the Netherlands equivalent was progressively rolled out during H2 (with some outstanding actions to take place in FY20). Additionally, ‘significant’ price increases were put through in Q4 to recover higher prevailing residue/non-recyclable material disposal costs and together these features provided a notable boost to H2 EBIT margins in both countries and good momentum entering FY20.
Hazardous: testing market characteristics, remedial strategy in place
Management considered markets generating waste streams processed in this division to be active at similar levels to the prior year; headline declines of 8% in revenue and 65% in EBIT reflected two distinctly different features affecting the financial performances of Reym (cleaning services for industrial equipment) and ATM (treatment of contaminated materials). In the former case, there were fewer plant shutdowns and service schedule variability whereas at ATM there was a regulatory stop on the use of thermally treated soil. In each case, this led to cost control/ unrecovered overhead challenges. These characteristics were visible at the interim stage and did not improve materially in H2. Renewi re-set expectations for both businesses at the end of FY19 by commencing a disposal process for Reym and guiding towards no resumption of thermal soil treatment during FY20. In FY19, Reym was included in the Hazardous Waste figures reported in the earlier exhibits and although it is now seen as non-core, improved commercial terms have been put in place. At ATM, work continues with regulators to agree industry soil permit T&Cs and the company itself is running pilot-scale processes to separate constituent materials with a view to generating new market opportunities. Non-soil markets (ie water and chemical treatment) have not been affected.
Monostreams: mixed bag as in H1, actions taken to turn around weak performers
As Exhibit 2 shows, this division is the most dependent on outbound revenues (ie sale of processed materials and by-products including energy generation), which represented almost two-thirds of divisional income in FY19. In value terms, there was a small y-o-y drop in this category and Coolrec (electrical equipment recycling) was the most affected by this. In fact, divisional inbound revenues grew well (+ c €11m to c €72m) with both Orgaworld (organic waste processing) and Mineralz (incinerator ash re-processing) both likely to have been beneficiaries. Internal operational problems in glass recycling (Maltha and van Tuijl) negatively affected profitability. We note that the reduction in divisional outbound revenues was more marked in H1 and overall profitability was well down sequentially versus H1 and y-o-y against H218. New management teams are now in place at both of the underperforming businesses and a modest level of profit improvement is the guidance for this division in FY20.
Municipal UK:1 headline profitability improves but returns still at low levels
The headline figures state that UK Municipal profitability swung from a c €7m loss to a small profit in FY19 despite a 3% reduction in revenues. This was the result of some structural changes, long-term contract provisioning and a number of positive and negative trading features for the ongoing facilities. Exits from three facilities during the year (Westcott Park, Cumbernauld and Dumfries & Galloway) will have contributed to both reduced losses and revenue reduction although we are unable to quantify the aggregate effect here. We believe onerous contract provisions at Wakefield (essentially advance recognition of future lifetime losses released annually against actual performance) represented a swing of c €4m y-o-y. Otherwise, operational improvements at Cumbria and BDR supported improved profitability from ongoing facilities but the division also saw headwinds in the form of lower recyclate pricing and higher incinerator costs. With regard to the delayed new Derby plant, Renewi has fully written down its investment to date and delay-related damages carried and also provided for ongoing losses to an expected termination point at the end of September. As a result, the financial performance of the division overall should more closely reflect underlying performance. Management has guided to a weaker profit contribution expectation for FY20 versus FY19.
Increase in core net debt driven by exceptional cash items
Core net debt for continuing operations ended FY19 at €552m, (excludes c €4m in businesses for sale), an increase of just over €50m on the year before non-cash, reclassification and FX translation effects which broadly offset each other. This was more than outweighed by outflows relating to exceptional items and ongoing contract provisions.
EBITDA showed a small y-o-y uplift, coming in at c €180m in our model. In reported operating cash flow terms, this was substantially retained given only a marginal group working capital cash outflow in the statutory cash flow statement in the period. With a relatively stable group revenue position this appears to be intuitively consistent. (It was, however, clearly less favourable than the payables-driven working capital inflow of c €19m seen in the prior year.) Pension deficit recovery cash payments were similar to the prior year at €3.4m.
Putting exceptional cash outflows to one side, net interest costs were lower y-o-y at c €18m – including positive effects from green finance certification – although minority dividend receipts were also lower. Cash tax payments rose to c €13m having utilised Belgian tax losses previously. Gross capex exceeded €107m, which was well above c €94m depreciation and internal amortisation combined. Almost €12m of this spend was categorised as growth oriented and included expansion at Mineralz (part of Monostreams, where a 20-year operator extension was secured at its Maasvlakte specialist landfill site) and at the Canada Municipal Ottawa composting facility. Asset disposal proceeds of c €8m brought net capex down to just below €100m in the year which, before exceptional cash items, left positive overall group free cash flow generation of c €46m.
This cash inflow was supplemented by c €24m proceeds from the disposal of interests in Energen Biogas (an anaerobic digestion facility in Cumbernauld) and a newly created ATM venture. Other net investments, including employee share trust purchases, were c €8m and cash dividend payments made in the year were just over €27m, in line with FY18.
Lastly, we note that non-recourse PFI/PPP net debt stood at €95.4m at the end of FY19, marginally higher than a year earlier, and the net result of modest cash inflows and adverse FX translation effects.
Exceptional items
The above free cash flow discussion is of course not an entirely fair representation given that some of the improved profit performance arose following post-merger actions taken incurring associated exceptional cash costs. We now show the breakdown of new P&L exceptional charges in FY19 and exceptional cash outflows in the year. We estimate that around one third of the €145.1m P&L charges had cash implications, not all of which flowed out during FY19. On our analysis, gross cash outflows approached €90m; integration/synergy actions and UK Municipal onerous contracts were the largest contributors to this, as shown in Exhibit 3.
Cash flow outlook
In broad terms, we expect a neutral underlying cash performance in FY20, implicitly with free cash flow sufficient to fund a c €14m projected dividend payout. Consequently, the outflow shown in our model approaching €40m is driven by further exceptional items, the majority of which relate to additional integration/synergy actions and UK Municipal onerous contracts. Renewi expects to deliver €10m further synergy benefits during FY20 to take the total to €40m, as in the original merger plan. Our estimates do not factor in prospective proceeds from the disposals of Reym and Canada Municipal; management has states that together they could reduce the group net debt: EBITDA ratio (with both variables changing) by c 0.5x compared to 3.06x at the end of FY19.
Existing core banking arrangements include a net debt: EBITDA covenant of 3.5x which reduces to 3.0x in June 2020. In the context of our model, this suggests that disposals are likely to complete during FY20. Over 70% of Renewi’s c €800m facilities run at least to 2023, the notable exception being a €100m retail bond maturing in 2019. This is to be repaid from existing €252m (undrawn RCF and cash) headroom and we assume that average borrowing costs will reduce as a result.
Earnings estimates unchanged; FY20 dip followed by growth
The economic backdrop is for low single-digit GDP growth in Renewi’s primary markets. Price increases at the beginning of 2019 and the delivery of further synergy benefits and operational improvements together should drive progress in the Commercial and Monostreams divisions. However, both Hazardous Waste and UK Municipal are expected to make reduced contributions in FY20 and we anticipate c 10% lower group EBIT y-o-y. The expected ramp up of activity at ATM from FY21 onwards is an important contributor to our projected earnings profile. Our headline PBT estimates are unchanged for FY20 and FY21 (with lower central service costs offsetting the now removed Municipal Canada profit in our model) and the FY22 year is added for the first time.
