Renewi — Recycling 2.0

Sales declined 2% in H124, primarily due to lower volumes, particularly in some Commercial Waste sectors such as C&D along with lower recyclate prices. Operating margins declined from 7.9% in H123 to 5.4%, albeit H123 was supported by strong recyclate pricing suggesting the 6.1% in H223 may be a more realistic comparator. Exceptionals were positive driven by changes to the discount rates used for the UK Municipal provisions. Cash flow was controlled, highlighted by a working capital inflow of €5m. Core net debt increased marginally to €383m and the group retains facilities of €705m. Core net debt/EBITDA increased to 2.1x due to lower EBITDA.

The top line of the Commercial Waste division was stable as price increases offset lower volumes and recyclate pricing. Profitability declined due to market softness and time lags in price increases implemented to offset cost inflation. Two key elements of note were:

The performance of the Mineralz & Water (M&W) division was affected by lower volumes in ATM and planned maintenance pulled forward. Activity improved in Q2 with a positive H2 expected. The Mineralz business has contracts signed for 450ktpa, which underpin management expectation of a €5m profit uptick in the second half.

Key to the Specialities division were the solid performances from Coolrec (electronic and electrical equipment waste) and Maltha (glass waste) despite the impact of lower recyclate pricing on margins. The UK municipal businesses’ performances remains weak and cash consumptive, with the operations still subject to the current review.

The exceptional costs were significantly reduced in the period. The change in provisions reflect the changes to discount rates. The amortisation of acquired intangibles has increased due to the Westpoort acquisition made in 2022.

Net debt rose marginally due to the legacy issues and investment in growth capex. Management is guiding to an outflow of €30–35m for the full year, suggesting a slightly higher outflow in H2, which we would expect to include the c €5m cost of the additional restructuring programme and we have assumed no further working capital improvements.

Management guidance for the full year is unchanged from the comment made in the October update: ‘Current and ongoing demand conditions expected to be largely offset by the increasing contribution from cost actions, meaning the Group’s full year performance is expected to be broadly in line with the Board’s expectations’.

Commercial Waste Belgium will fully benefit from the new site at Ghent to support the latest Vlarema 8 legislation. Commercial Waste Netherlands will benefit from the Acht site development but is expected to see continued softness in the C&D business but margin improvement from cost cutting (€15m group annual savings are targeted primarily in Commercial Waste Netherlands starting December 2023), pricing and operational improvements. The division will also see the benefit, or lack of headwind, from falling recyclate prices, which appear to have stabilised. M&W will see significant improvement as ATM volumes increase and Mineralz throughput increases.

We have updated our forecasts to take into account the weaker performance than we had anticipated in the Commercial Waste Netherlands business along with a slightly higher tax rate and minorities. Clearly there is risk on the timing of the cost savings programme and the expected improvement in M&W volumes. A full financial summary can be found on page 12.

The recent capital markets event confirmed many of the positive trends for recycling highlighted in our preview note. Arguably the most interesting aspect was the medium-term financial targets management provided, highlighted in Exhibit 9. This section focuses on the achievability of these goals.

Exhibit 10 highlights management’s roadmap for margin expansion.

Recyclate prices have been volatile and were particularly beneficial in FY22 and Q123. Hence the correct starting point is arguably best reflected in the H223 margin of 6.1%. Below we consider the major steps in a little more detail.

The Renewi 2.0 programme has been completed with €20m of savings being generated (€17.8m in FY23). The digitisation programme is expected to generate further internal operational benefits while management initiates additional cost actions. Overall, management has targeted internal savings of €15m a year, which would add 90bp to operating margins.

Exiting will reduce revenue by c €200m and assuming 2% operating margin, we estimate this would add 70bp to operating margins.

Investment to increase the percentage of recycling (target from 63.6% to 75%) and the quality of recyclates should boost returns. Increasing recycling reduces incineration costs as Renewi does not own any such facilities; we note that ‘cost of waste’ accounted for 36% of the cost base in FY23. Higher-quality recyclates not only improve pricing but also assist in moving away from the commodity pricing fluctuations.

Investment is being targeted in areas that promote recycling and recyclate quality. The €60m investment in advanced recycling at Ghent, Puurs and Limberg provides the clearest example. Recent Vlarema 8 legislation in Flanders requires companies to increase the level of waste sorting and recycling, with up to 24 different waste streams to be identified with significant penalties for non-compliance. This should lead to more waste being diverted away from incineration/landfill and additional processing, adding value to the stream and profitability to Renewi.

Key is the soil remediation business, which has been loss making but historically generated over 10% margins. Management is looking to double throughput with contracts for a 50% increase to 450kt already in place. This will provide greater overhead recovery while the move to higher-value products (sand, gravel and filler) should also assist in turning around the fortunes of ATM. 10% ROS would add c €20m to EBIT and improve group margins by c 100bp.

On the negative front, there will clearly be challenges from inflationary pressures, which management will aim to pass through via pricing along with the inevitable ebbs and flows of recyclate pricing, as seen in FY23.

Our analysis suggests that the benefits from digitisation/SG&A, UK Muni resolution and M&W recovery, which we have also separated out, would achieve the targeted margin improvement. This leaves additional potential from the growth and recycling initiatives depending on the ability to offset the current inflationary headwinds. Peer group analysis has limitations due to the differing business models, but Exhibit 11 shows the potential for best in class, which is clearly management’s goal.

Exhibit 12 highlights the group’s recent growth profile including the impact from COVID-19 in FY21 and recyclate pricing in FY22. Management’s plan for 5% organic revenue growth compares to the 3% seen over the last five years.

Management set out some clear targeted avenues for expansion, which are being backed by significant capex (€30.8m in FY23 and expected to be €50m in FY24).

The €275m revenue growth potential would translate to only c 3% annual growth. This is similar to the historical growth rate of 3% over a five-year period when the focus was on internal operational performance and margin improvements, suggesting a positive underlying market clearly exists, which should also assist. Current inflation pricing trends are also likely to promote the top line. It is also worth reviewing the growth being achieved by Renewi’s European peers, clearly above the 5% management target.

Management is targeting operational free cash generation, which includes maintenance capex but excludes growth orientated capex, equal to 40% of EBITDA against 10% seen in FY23. Our analysis in Exhibit 15 assumes five years as ‘medium term’ and incorporating the operating targets suggests this is achievable, provided the legacy liabilities (UK Muni, ATM and COVID tax) are all resolved and the medium-term margin targets are achieved. Note that overall cash generation will be restricted due to growth capex (€30.8m in FY23 and expected to be €50m in FY24 with plan to invest c 30% of free cash flow) and the announced plan to recommence paying dividend (3-4x cover suggests a €40m annual cash cost in the medium-term scenario).

The company is targeting >15% ROCE, up from 10.6% reported in FY23, suggesting c 5% improvement. Our analysis uses a slightly different return on capital formula (underlying EBIT to total assets less current liabilities), which produces a slightly lower figure. As Exhibit 16 highlights, Renewi’s performance is not out of line with peers.

Going forward, margin expansion will assist as will the commercialisation of the investment capex. The impact of any exit of the UK Muni businesses, particularly on the balance sheet, is unclear at present. Hence, we see improvement potential but also see 15% ROCE as the hardest target for management to achieve.

There are clear positive market fundamentals at both the European level (eg the European Green Deal) and the local level (eg Flanders’ Vlarema 8 advanced waste sorting requirements). Combined with the expansionary capex, we see the 5% growth target as achievable, as peers are also reporting. Much of the expansion will be in higher-value sorting, recyclates and services, which, along with the internal actions, should boost returns. The key will be ROCE to ensure that management is generating real value. Here, we note that ROCE accounts for 25% of management’s LTIP, suggesting positive alignment and incentive.

Management has initiated a review of the UK municipal operations. Exhibit 17 highlights the continued cash consumption from these activities. Hence an exit would be positive for both ongoing financials and, we would expect, for investor sentiment.

Our note A circular economy champion contained a detailed valuation and methodology; an update for the key discounted cash flow (DCF) and peer group valuations is provided below. Exhibit 19 highlights our new valuation and changes, incorporating our revised forecasts. Based on short-term profitability metrics (FY24 and FY25) and softening peer stock prices, the peer group based valuation sees the greatest impact. Our longer-term orientated DCF valuation remains virtually unchanged.