About a year ago, I concluded, or better said wondered, if investors were collecting garbage at prevailing share price levels at the time in the case of Casella Waste Systems, Inc. (NASDAQ:CWST). I called the business a long-term value creator in garbage collection and recycling markets in Northeastern parts of the U.S. While the track record is strong and the future prospects look good, valuations have gone too far in my eyes, a conclusion which I still underwrite today.
A Recap
Casella is an integrated waste collector, which means that besides collection of waste it offers recycling and other activities as well. The company has a solid network in states like New York, Rhode Island Massachusetts, Vermont, New Hampshire, Maine, and Connecticut, in which it has critical mass and density of its network.
A year ago the operations comprehended 50 collection operations, about half that number in recycling facilities, 9 disposal activities, a couple of landfill gas-to-energy operations, and numerous transfer stations.
The company has seen steady growth, having grown revenues by about 50% in the time span of about 5 years, keeping margins steady in their twenties. The company derived about three quarters of a $900 million revenue base in 2021 from solid waste activities (collection and disposal), with recycling activities being responsible for the remainder of revenues.
While some investors believe that waste collectors see pressure on their businesses with society moving to less packaging and trash over time, it is actually the focus on recycling which means that the value add of garbage might be on the increase. In fact, landfill volumes (in the case of Casella) have been down 10% between 2016 and 2021, with revenue growth being the result of pricing and other activities.
This positive dynamic was priced in, as a $6 shares in 2016 rallied to $77 at the moment of writing, that is May of last year. To put this valuation into perspective, we look at the 2021 results, a year in which revenues were up 15% to $889 million, with EBITDA margins improving a point to 23% of sales, thereby coming in at $204 million in dollar terms. Note that the business is quite asset intensive, with GAAP earnings reported at $41 million, and adjusted earnings coming in slightly higher at $46 million.
The 51 million shares outstanding valued equity at $3.9 billion at $77, as a $508 million net debt load (equivalent to 2.5 times EBITDA) created a $4.4 billion enterprise valuation. With GAAP earnings only seen around $0.80 per share, the resulting 100 times earnings multiple was steep by all means.
This remained the case, even as the company announced that it saw EBITDA rise to $234 million on a billion revenue number, and earnings improve to $50 million for 2022. The company furthermore announced a bolt-on deal for Northstar, adding $26 million in (recycling) revenues. While earnings might improve to a dollar per share, the valuation was far too high for me to get involved. This is despite the rosy long-term prospects, as I was fully aware that the market and investors have not perceived the prospects as such in historical time periods as well.
Still Going Strong
Forwarding about a year in time, we have seen that shares have risen on a net basis from $77 to $87 per share. The company has seen some growth in terms of the number of facilities ever since, and it has increased the share of recycling and energy revenues to 27% of sales, reducing the reliance on solid waste. Pricing for solid waste was very strong, as the number of landfills in the region was down, in part due to fewer permits being granted.
In February of this year, Casella posted strong 2022 results with revenues up 22% to $1.09 billion. As predicted, net earnings topped the $50 million mark, coming in at $53 million, or $1.03 per share, as the company posted an adjusted earnings number of $1.10 per share. Adjusted EBITDA was improved to $245 million, coming in ahead of the original guidance. The company furthermore guided for a solid increase in key metrics for 2023, with sales seen up to $1.15-$1.18 billion and adjusted EBITDA set to increase to a midpoint of $269 million.
Late in April, the company reaffirmed the full year guidance alongside the release of the first quarter earnings results, as the company is granted a $5 billion enterprise valuation at $87 per share.
Just a few days ahead of that earnings report, the company announced a substantial deal. The company had reached a $525 million deal to acquire the collection, transfer and recycling activities of GFL Environment in Pennsylvania, Delaware and Maryland. With a $185 million revenue contribution, the resulting 2.8 times sales multiple was a lot cheaper than its own valuation, in excess of 4 times sales, with the deal set to add about 15% to pro forma sales.
With a $45 million EBITDA contribution, the resulting 23% EBITDA margins were at par with the own operations, so this really seems like a (relative) bargain. On top of the lower multiple, the company sees $8 million in synergies by year three, recognizing $132 million in tax benefits over time as well.
Net debt will jump to about a billion, equal to 3.6 times net leverage, which is on the higher side, but the reliable cash flow generation should allow for some deleveraging rather quickly.
This deal was actually followed by another big deal in June, when Casella acquired Twin Bridges in a $219 million deal, as a $70 million revenue contribution revealed that a 3 times sales multiple has been paid for these activities as well. The deal adds more operations in the Albany region, as an $18 million EBITDA contribution reveals similar margins as the own business, with another $4 million in synergies seen over time as well as tens of millions in tax synergies.
This deal would push up net debt to more than $1.2 billion and likely above 4 times EBITDA, hence the decision of the company to sell 5.2 million shares in June at $85.50 per share (essentially locking in the difference in the valuation multiples) in an effort to raise nearly $450 million in gross proceeds. That is set to reduce net debt to about $800 million, and keep leverage ratios well below 3 times.
What Now?
The net impact of all of this is hard to model amidst some deals and dilutive equity issuance, but the net impact should be favorable from an earnings per share perspective.
That being said, even after another year of double-digit earnings per share growth, this only results in earnings per share which supersede the $1 per share mark by a modest margin, still translating into sky-high earnings multiples.
While Casella Waste Systems will happily point towards greater cash flow numbers, the business is still quite capital intensive, among others due to the electrification of the fleet and further investments into facilities.
Given this, I continue to appreciate Casella Waste Systems stock and the prospects, but simply disagree with the lofty valuations applied to the business here.
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