Share Dilution

Casella Waste: Valuation Could Harm Future Performance (NASDAQ: CWST)

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Investment thesis

This article reviews Casella Waste Systems, Inc. (NASDAQ: CWST), one of the fastest growing waste management players in North America. I think the company has a large moat and continues to benefit from strengthening end markets and good pricing power. The stock has performed very well in the past, clearly outperforming the S&P 500 and other peers over the past decade. However, the stock is not cheap at the moment. The company trades at around 42 times next year’s adjusted free cash flow, making CWST one of the most expensive companies in the waste management industry.

Refinitiv Eikon

Refinitiv Eikon

Company presentation

Casella Waste Systems, Inc. is a regional, vertically integrated, solid waste management services company that provides resource management expertise and services to residential, commercial, municipal and industrial customers primarily in the areas of management services solid waste in six states: Vermont, New Hampshire, New York, Massachusetts, Maine and Pennsylvania. The Company manages its solid waste management operations on a geographic basis through two regional segments, the Eastern and Western regions, each of which provides a range of solid waste management services.

CWST had approximately 50 solid waste collection operations, 65 transfer stations, 23 recycling facilities, 9 alternate disposal landfills, 3 landfill gas-to-energy facilities, and 1 landfill licensed to accept building materials and demolition.

Investor Presentation

Investor Presentation

The market opportunity

The world generates 2.01 billion tons of municipal solid waste per year. There is a positive correlation between waste generation and income level. Daily waste generation per capita in high-income countries is expected to increase by 19% by 2050, compared to low- and middle-income countries where it is expected to increase by around 40% or more, according to a World Bank report.

Projection of waste generation by region

world Bank

According to a recent research reportthe global Waste Management Market size was valued at USD 1,612.0 Billion in 2020 and is projected to reach USD 2,483.0 Billion by 2030, registering a CAGR of 3.4% from 2021 to 2030. If we look to North America, the waste management market should to reach $229.3 billion by 2027, from $208.0 billion in 2019, registering a CAGR of 5.3% from 2020 to 2027. In 2019, the United States dominated the market in terms of revenue , representing approximately 92.45% of the North American waste management industry. , followed by Canada and Mexico. Considering that the US economy is expected to grow in low single digits during this period, it is likely that companies involved in the waste management sector will outperform other sectors in the coming years.

Business strategy

CWST derives approximately 74% of its revenues from solid waste, which consists primarily of integrated collection, transfer, landfill energy and treatment services. The remaining 26% comes from resource solutions, which consist of processing operations such as recycling and non-processing operations such as brokerage.

Investor Presentation

Investor Presentation

CWST is growing rapidly in an industry where competitors tend to grow at a mid-single digit rate. As a reminder, the North American waste management industry should to grow approximately 5% per year through 2030. Since FY16, the company’s revenue has grown at a median rate of 10.25% driven by organic growth and acquisitions. Acquisitions in particular played a key role in the growth strategy. To put it into perspective, CWST has acquired 39 solid waste businesses since the first quarter of fiscal 2018, which added approximately $240 million to total annualized revenue. These acquisitions represent approximately 27% of LTM revenue. Moreover, there is no indication that CWST is slowing down its acquisitions. In the first 45 days of FY22, the company completed 5 additional add-on acquisitions with approximately $4 million in annualized revenue.

Investor Presentation

Investor Presentation

At the same time, adjusted EBITDA increased from $121 million in FY16 to $204 million in FY21. I like that CWST has been able to grow profitably over time and has actually expanded its margins from 6 years ago.

Investor Presentation

Investor Presentation

The company has adopted a strategic plan in 2017 which is based on 4 main pillars to drive value creation. These pillars are to increase landfill yields, generate incremental profitability in collection operations, create incremental value through resource solutions, and allocate capital for yield-driven growth. Going forward and based on management’s expectations, the strategy should generate organic revenue growth of 4-5% per year, combined with a minimum of $30 million per year in revenue from acquisitions. Adjusted free cash flow is expected to grow at a rate of 10-15% per year through 2024. If management is able to achieve the above targets, the business will grow at a faster rate than the industry and the most of his peers. , which is one of the key arguments in the bull thesis.

Investor Presentation

Investor Presentation

Evaluation

Based on 51.3 million shares outstanding and a price of $86 per share, the company has a market capitalization of approximately $4.4 billion. In this part, I used a discounted free cash flow model to value the business. The following assumptions were made in the model:

  • Estimated free cash flow for FY22 of $105 million based on Wall Street estimates.
  • A 3-year FCF growth rate of 12.5%.
  • A terminal growth rate of 3%.
  • An 8% discount rate, based on the company’s WACC.

Author

Author’s model

According to the model, the intrinsic value of CWST is close to $52 per share. If we compare this to the current stock price, the stock is significantly overvalued and offers no margin of safety at the current valuation. Also, my model does not take into account the dilution that could occur when the company issues new shares. In the past, CWST relied heavily on equity issuance to fund its acquisitions. To put it into perspective, shares outstanding grew from ~41 million in FY16 to ~51 million in FY21, representing a 24% increase.

Key points to remember

In summary, I think CWST has a good business model and a moat. Going forward, I expect adjusted free cash flow to grow at least 10% per year from organic sources and through acquisitions. In terms of valuation, CWST is not cheap at the moment. The company is trading at around 42 times next year’s earnings. Therefore, I think the current valuation does not provide a good margin of safety.