Cleanaway Eyes Margin Growth, Cash Upside

Australia | 10:30 AM

Brokers see Cleanaway Waste Management’s updated strategy as positioning the company for earnings upside.

• Cleanaway Waste Management outlined its updated strategy this week
• Focus firmly on operational efficiency and free cash flow
• Fuel costs and Middle East risks persist
• Year-to-date share price weakness generally seen as an opportunity
• Management did issue a profit warning in mid-April

By Mark Woodruff

Cleanaway Waste Management ((CWY)), a provider of waste management and environmental services in Australia, issued a strategy refresh briefing this week outlining medium-term targets for earnings growth and ongoing margin expansion.

The company’s shares had fallen around -10% year-to-date prior to the briefing, which UBS attributes largely to a recent track record of inconsistent delivery on cash and earnings expectations, as exemplified by an earnings guidance downgrade just over a week ago.

The broker also points to increased investor caution around Middle East-related fuel cost inflation.

Management's strategy update focused on capital investment, circular economy growth, operational efficiency and free cash flow (FCF) growth through to 2030.

In short, improved capital discipline and greater utilisation of existing assets are expected to provide a clear pathway to higher FCF from FY27 and beyond.

According to Morgans, investors should be encouraged by management’s emphasis on improving FCF, a metric which has historically lagged underlying earnings growth.

Cleanaway’s largest reporting segment is Solid Waste Services, which includes municipal collections, landfill, transfer stations and recycling operations.

Industrial & Waste Services focuses on hazardous waste, industrial cleaning and resource recovery solutions, while Liquid Waste & Health Services also encompasses specialised areas such as healthcare and oil-related waste streams.

Across these divisions, Cleanaway manages an extensive national network of facilities, fleets and recycling infrastructure, allowing it to capture value across the waste lifecycle from collection to processing and recovery.

Certainly, management believes FCF is “at an inflection point”, and the inclusion of FCF targets in the executive short-term incentive plan underscores its importance to shareholders, Morgans suggests.

As Charlie Munger used to say, “Show me the incentive and I'll show you the outcome".

Blueprint 2030 and targets

Cleanaway has laid the groundwork through strategic acquisitions and is now building execution momentum, in Morgan Stanley’s view.

Certainly, RBC Capital believes the Blueprint 2030 strategy positions the company well to maintain its dominant upstream position in collections and separation.

This broker also sees scope to capture downstream opportunities in underdeveloped waste streams, while continuing to extract greater value and efficiency from residual waste streams and landfill assets.

Management expects FCF improvements to be supported by the completion of one-off restructuring costs and catch-up tax payments, reduced capital intensity following network investment, and benefits from strategic initiatives, including indirect cost reductions.

Focused on extracting greater shareholder value from investments made in Phase 1, Cleanaway’s Phase 2 strategy introduces medium-term targets for more than 260bps of EBIT margin expansion from FY26-FY30 from the FY26 base, versus consensus expectations of around 160bps, according to UBS.

According to Morgans, current consensus forecasts imply a more modest expansion of around 170bps over the same period. However, it's felt the FY27 EPS estimate may need to be downgraded as it hasn’t factored in the higher rates environment into interest costs.

The company outlined a medium-term EPS growth target of 10%-15%, alongside rising returns on invested capital, supported by a disciplined “mid-teens” internal rate of return (IRR) hurdle for growth capital.

Accordingly, management declined to provide explicit capex guidance for this phase.

Management also intends to maintain a dividend payout ratio of between 50%-75% of underlying profit.

A key focus of the strategy for FY27-FY30, according to Morgans, is extracting greater value from the company’s established operating platform.

To achieve this, the analyst explains the strategy centres on three pillars: delivering customer value through competitive pricing and seamless service, optimising the branch network, and adopting more advanced ways of working through investment in technology, data and analytics.

These initiatives are expected to drive higher-quality revenue growth and improved margins, alongside stronger cash flow and returns through better asset utilisation and lower costs and maintenance capital intensity.

UBS explains a focus on revenue management aims to leverage Cleanaway’s prior investment in CustomerConnect, a centralised customer and sales platform.

This platform centralised the sales force and now allows for dynamic pricing and targeted growth in wallet share through data analytics, the broker explains.

FY27 tailwinds

Morgan Stanley forecasts a 15% year-on-year rise in earnings (EBIT)  for FY27 to $542m, driven by cost-out initiatives, fuel cost recovery, normalisation of fuel mark-to-market, and contributions from Contract Resources and Citywide Waste, including synergies.

The broker remains positive on Contract Resources despite current limitations in the Middle East, noting potential upside from facility restoration work.

Ongoing digitisation initiatives, spanning customer service, fleet optimisation and pricing, are also expected to support further cost savings and operational momentum.

Recent earnings downgrade

On April 15, management lowered FY26 EBIT guidance to $460m-480m from $480m–500m due to increased fuel costs and disruption to its Middle East operations from the war between the US/Israel and Iran.

Ord Minnett explained the impact would be felt through higher direct fuel costs, increased third-party logistics expenses, and reduced activity in the Middle East segment of the company’s Contract Resources business, a specialist operator in the oil and gas industry.

Management said the effect of fuel price increases was not a structural challenge to its margins given its contracts were structured so Cleanaway could recover "a substantial portion of the fuel increases over time".

Ord Minnett at the time expected margin pressure from higher fuel costs to ease by the second half of FY27. Depending on fuel price movements, it was thought margins could temporarily expand before normalising to pre-war levels.

The bulk of the impact from rising diesel prices will likely be absorbed within the Solid Waste Services division, Jarden assessed, where Cleanaway’s fleet intensity is highest.

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