Renewi — On the front foot and targeting strategic progress

Renewi ended a COVID-19 disrupted FY21 with good trading momentum in Commercial Waste, its largest division. Following a series of H2 upgrades, reported profitability was still ahead of our estimates (by c €5m at the EBIT level and c €8m for PBT). Moreover, core net debt was managed down by €110m to €344m (2.2x EBITDA generated in the year) through a combination of strong underlying cash inflow and temporary tax timing benefits. Our revised estimates show Renewi’s earnings exceeding FY20 levels in FY23, returning to paying dividends in that year and making further progress in both regards in FY24 (see Exhibit 4).

Renewi’s FY20 ended as the commercial implications of the developing COVID-19 pandemic were beginning to be felt and the start of FY21 was similarly affected. Local lockdown conditions had a more marked impact in Belgium compared to the Netherlands, although the collection and processing of waste was declared an essential service at an early stage. Renewi kept its depot infrastructure fully operational throughout and received only modest income from the Belgian government under its temporary unemployment scheme.

Exhibit 2 shows the scale of the volume reductions felt in Q1 (April being particularly hard hit) followed by generally narrowing year-on-year shortfalls as FY21 progressed. In both countries, revenues saw less year-on-year impact than volumes – in fact Netherlands’ sales rose modestly – and we discuss the mix effects behind this in the following sections.

Income generated from inbound waste (ie collection and gate fees) dominates Commercial revenues and was pretty stable in both half years, being down just 2% for FY21 as a whole. The other three categories showed fairly sharp contractions in H1, which were more than compensated for by strong rebounds in H2. The most material of these to the overall divisional outturn was the recovery in outbound revenues driven by strong recyclate prices (particularly paper and metals). Otherwise, on-site activity (eg hospitality industry) was understandably constrained at the beginning of H1 and freed up again in H2, while the other category (eg industrial) ultimately made the most progress over the year. These effects are summarised in Exhibit 3.

The improved second-half momentum is shown clearly in this table, and drove several upgrades to guidance and our estimates during the period. As a result, divisional EBIT was only c 3% below the prior year in FY21 and, against our expectations, EBIT in both the Netherlands and Belgium came in c €3m better than we had anticipated ahead of the results.

Netherlands: country revenue rose by 1.9% in FY21 on total volumes that were down c 5% for the year (including 1.4% in waste streams considered to be core1). Construction sector activity remained firm across the year and bulky (residential) waste was particularly strong for the first three quarters before settling back in Q4. In general, the other core sectors recovered well after a weak Q1, although traded largely below prior year levels. Increased home working and restrictions placed on the leisure/hospitality industry meant that commercial and roller bin waste streams respectively were the weaker segments. Overall, the Netherlands’ top line was modestly ahead year-on-year in FY21, but the country EBIT margin improved by 40bp to 6.5%. Operational gearing was visible in both half years – negative in H1 and strongly positive in H2 – so we conclude that the favourable volume mix as H2 progressed was responsible for the improving profit expectation and ultimate outcome in the Netherlands. Firming recyclate prices contributed to this outturn.

Belgium: initial lockdown conditions were more severe in Belgium, as clearly seen in the H1 revenue and EBIT contraction. The H2 recovery was more muted than the Netherlands, although broad parity with the prior year was achieved at both revenue and EBIT levels. For the year as a whole, country revenue declined by 6% with total waste volumes down 12%. With one exception, waste stream subsector activity was similar to that seen in the Netherlands, including slightly better year-on-year outturns in commercial, recyclates and construction/ demolition volumes in Q4. In contrast, bulky waste volumes remained well below FY20 levels for the whole of FY21, although we believe that it is typically a smaller subsector than in the Netherlands under normal circumstances anyway. Renewi responded to the contraction in activity and profitability in H1 by announcing the closure of two sorting lines, and cost reductions here contributed to the EBIT recovery in H2. It should be noted that investment in capacity in plastics (commissioned) and sand (ongoing) also took place to improve the quality of processed materials for resale. Overall, Belgian revenue declined by 6% in FY21 with an EBIT margin 100bp lower at 5.6%, and this was substantially due to lockdown effects in Q1/H1.

This division processes contaminated soil, water, sludge and mineral residues and generates the highest proportion of recycled materials (82% of volume) and also the highest proportion of landfilled materials (17%) of Renewi’s three divisions. Including a specialist metal extraction facility (transferred from Coolrec/Specialities) for the full year meant that inbound income accounted for three-quarters and outbound one-quarter of divisional revenues in FY21. In underlying terms, we estimate that inbound and outbound revenues were broadly flat year on year.

Divisional trading performance has been dominated by restrictions on reusing thermally treated soil (TGG) in the Netherlands; this pre-dated the COVID-19 pandemic and, although the block was lifted in December 2019, the issuance of local, application-based activity permits has been slow to kick in. ATM did ship 140,000 tonnes of TGG in H121 but inventories of inbound and processed soil have restricted further intake/processing activity, affecting revenue generation. The intake of contaminated water, sludges and chemical waste at ATM’s waterside facility is not affected in the same way, although COVID did affect volume activity levels at the beginning of the year. Consequently, we estimate that ATM performed at a similar level to FY20 in revenue terms while underlying EBIT – after taking c €4m external storage costs above the line and incurring disposal costs on the TGG shipments that did take place during FY21 – was slightly lower year-on-year and a small operating loss. In addition, a new €3.5m provision for higher expected disposal costs – also above the line – further reduced reported profitability.

Mineralz (soil washing, mineral/metal extraction, secondary building materials production and landfill operations) saw some disruption to landfill activities in Q1, with COVID affecting volumes here. Also, in H2, the Braine-le-Château site ceased intake operations, leaving Maasvlakte and Zweekhorst (both in the Netherlands) as the only operational landfill sites now. Otherwise, volumes were generally stable to slightly better year-on-year, and the inclusion of Coolrec’s Tisselt metal extraction facility (c €29m revenue and modest profit) would have benefited the top line directly and through improving metals pricing towards the year end. This is also reflected in the sharp increase in outbound revenues seen in the year (from c €16m in FY20 to c €46m in FY21).

We will continue to monitor progress in both inbound and outbound revenue streams in future periods as they will provide important markers of success emanating from internal actions, especially at ATM, in our view. In the first instance, any material pick-up in inbound revenues is likely to signify that soil inventory has reduced, freeing up production and storage capacity for fresh intake. Renewi’s management has commented that ATM has rebuilt its inbound soil pipeline (to more than 0.5m tonnes) and has signed contracts for the minimum placement of 0.5m tonnes of TGG, which – subject to successful placement – provides a marker of potential activity levels. Secondly, ATM’s investment in secondary processing facilities (to separate treated soil into graded sand, gravel and filler to be used as recycled production materials) should translate into an uptick in outbound revenues subject to a) successfully restarting soil intake, and b) market acceptance/certification of processed materials.

Overall, in underlying terms, we believe that the Mineralz & Water division achieved a similar revenue and trading profit performance to that seen in FY20. This is after adjusting for the inclusion of the transferred metal recycling facility and ATM’s additional provision, which had primary impacts on divisional revenue and profitability respectively.

This division comprises three independent specialist companies including UK Municipal (the largest in revenue terms, operating multi-factor waste facilities), Coolrec (recycling of white goods and small electrical appliances) and Maltha (glass recycling)

Taking geographic revenue splits as a proxy, UK Municipal activity levels appeared to improve modestly in FY21, with revenue at or above €200m (c £180–190m). Volumes exceeded prior year levels in all four quarters, materially so during H1 with an increase in working from home generating residential black bin waste. Management also commented that recyclate volumes were down, which both amplifies the first point but also probably represents a mix change that adversely affected underlying profitability. After taking into account full year effects from revised arrangements at the Derby recycling facility (which moved onto a short-term management-only contract in August 2019) and cost savings from self-help actions, UK Municipal profitability improved to around the break-even level, we believe. There was no additional net impact on reported results from movements in provisions.

Adjusting for the metal extraction facility transferred to Mineralz & Water, and after a COVID-19-affected Q1, Coolrec activity levels recovered well to slightly above FY20-equivalent levels for the remainder of the year. With a consolidated footprint after prior year restructuring, the company’s EBIT contribution more than doubled. Furthermore, investment to expand capabilities in Belgium led to a contract (six years with options for a further three years) to process 100% of the country’s fridge recycling requirements, providing both a volume uplift from 75% previously and improved business visibility in this area.

Renewi’s glass recycling JV Maltha (67:33 ownership with O-I, consolidated P&L with minority adjustment) was clearly and directly affected by the COVID pandemic with much reduced end-market activity in the leisure and hospitality sectors. While some recovery was seen from Q1 lows, the remaining quarters of FY21 were still c 10–15% below prior year levels in volume terms and revenues were likely to have been down by c 20%. While the business remained modestly profitable, this was at substantially lower levels than in FY20 and Renewi took a partial goodwill impairment charge of €9.5m in FY21.

As reported as FY21 progressed, Renewi successfully managed cash flows throughout the year and reduced core net debt by c €114m to €344m by the year end. Around half of this improvement came from earnings generated and close control over outflow line items and half from temporary tax payment timing benefits (see below). FX translation represented a c €7m adverse movement at year-end exchange rates.

On a pre-IFRS 16 basis, EBITDA of c €160m was slightly below the prior year and a creditable outturn given market challenges arising from the COVID-19 pandemic. In underlying terms, Renewi achieved a working capital inflow of c €35m, principally driven by good receivables collection. As referenced earlier, the deferral of cash tax payments permissible under business support initiatives by national governments also allowed for the retention of €54m cash within Renewi in the year, with a clear timetable for subsequent payment (see below). These features were the primary components of c €258m cash generated from operations in FY21. In addition, on a net basis, the recognition of €43m right of use asset depreciation as operating cash inflow under IFRS 16 exceeded provision-related outflows of c €32m (c 60% for Municipal onerous contracts, c 40% for spending on restructuring/integration/synergy capture under strategic initiatives) and smaller other outflows (eg pensions recovery cash).

Net financing costs of c €19m (after minority dividend receipts) and actual tax payments of €15m together absorbed €34m of cash, while Renewi spent c €62m on net capital expenditures. Set against c €80m of owned asset depreciation, the corporate emphasis was clearly on cash preservation and necessary spending only. Around €7m of capex was applied to growth projects including silos for graded materials at ATM and food waste recycling in Commercial. After all of the above items, free cash flow generated in the year was €162m. Leaving the tax deferral benefit to one side, the underlying c €108m generated was approaching double the level seen in FY20.

No dividends were declared or paid during FY21 and net PPP cash inflows meant that corporate investment was modestly positive overall also. After taking into account equity purchases (for the Employee Share Trust), repayment of PPP debt and c €40m of lease principal repayments, net underlying cash generated by Renewi in FY21 was c €117m (prior to FX translation effects).

IFRS 16 leases on hand rose by c €21m to c €248m at the year end (with €234m right of use assets recorded on the balance sheet). In broad terms, this was the net result of c €40m principal repayments and c €61m new leases taken out with an ongoing renewal of fleet vehicles, targeting progressively improving emissions and carbon footprint characteristics. For completeness, non-recourse PPP debt relating to UK Municipal operations was reduced slightly at €88m. Together with the core net debt and lease liabilities outlined above, total financing sums to the reported overall group net debt of €668m.

Cash flow outlook: after an understandably restrained year with regard to investment, we expect to see a more overt front-foot agenda in FY22 with capex guidance of c £120m (around one-fifth of which is for growth projects and some catch-up spending within maintenance capex). There are also flagged discrete outflows expected for:

We expect to see a further recovery in activity levels across Renewi’s business – which should be especially visible in year-on-year terms in H122 – have upgraded our profit expectations (see below) with progress anticipated in all three forecast years. This said, the above factors will restrict free cash flow generation to modest levels in FY22 in our opinion and although improving in the following two years will result in core net debt sitting between end FY21 levels and €400m in our model. There is clearly some discretion in the capex line as there is with regard to dividend payments. We anticipate Renewi resuming dividend payments in FY23 and core net debt of c €400m (2.1x EBITDA) at the end of this year and FY24.

The upgrades to our group estimates shown in Exhibit 4 are chiefly driven by our expectations for the Commercial Waste division in both the Netherlands and Belgium. It should be noted that the positive end to FY21 trading was progressively reflected in successive upgrades to estimates during that year but those for subsequent years were left largely unchanged. So, to some extent, changes to FY22 and FY23 reflect a catch-up on momentum previously noted. Other changes are comparatively minor on a net basis, though we have tempered the projected rate of profit recovery in Mineralz & Waste, which also captures the dampening effect of rising TGG soil placements by ATM.

After COVID-19 related challenges in FY21, Renewi has emerged in a stronger financial position and has reaffirmed ambitions to rebuild and grow group profitability. We have covered this in a previous note, but as a short re-cap, the company’s roadmap to achieve this is through three primary routes:

Each of these strands aims to add €20m to group EBIT over a three- to five-year period (FY20 baseline). We consider there to be some overlap between points two and three but the extent depends on how much of ATM’s recovery is driven by graded building materials sales. However, our updated estimates only include a c €30m uplift between FY20 and FY24 (from c €75m to c €105m), so successful implementation on a broad number of fronts would still represent earnings upside potential in our view.

It is still comparatively early days in this strategic cycle, but the delivery of Renewi 2.0 is underway and we include an updated financial summary on management’s expected costs and benefits in Exhibit 5.

Updating this table from a year ago, FY21 is now actual rather than expected and we note that c €2m P&L benefit was delivered in this financial year (versus the €1m originally anticipated). Higher capex spend and lower exceptional costs charged in FY21 suggest a slightly different phasing to the execution, though the total expected spend in each category is unchanged in aggregate as is the annualised benefit target for FY24.

We have covered FY21 trading and the immediate outlook for ATM earlier in this note, but Renewi has also updated its ‘Innovation pipeline’, which supports the qualitatively higher recycling target in bullet point three above. A mattress recycling JV in conjunction with IKEA (Retour Matras) has quickly expanded to three sites in the Netherlands, with a further one to open later this year and prospectively one in Belgium to follow. We believe that this JV is being independently funded, but other projects – such as expansion in organics/food waste processing, with expected capex of €20m – will require capital spending. Other projects are at different development stages and new ones are being added (such as in plastic recycling and residual waste sorting). We have modelled capex in excess of €100m in each of our estimate years to reflect the likelihood of some of these growth projects reaching the commercialisation stage. From the outside, we cannot determine the composition at this stage and, indeed, absolute levels so our estimates should be treated as indicative. It should be noted that the appetite for material investment and the returns that are expected to be generated will also inform Renewi’s dividend trajectory as part of the company’s capital allocation process.