Biffa BIFF
February 04, 2019 - 11:59am EST by
ad17
2019 2020
Price: 177.00 EPS 0.20
Shares Out. (in M): 250 P/E 8.9
Market Cap (in $M): 443 P/FCF 11.7
Net Debt (in $M): 303 EBIT 71 79
TEV ($): 746 TEV/EBIT 10.5 9.5

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Description

Long Biffa (BIFF LN): long-term compounder in the UK waste management industry. 70% upside to 12 month price target, potential for 3x return over 5 year horizon in a highly defensive end market.  

  • Similar to the US in the early 1990s, the UK waste collection and disposal market is highly fragmented, with the largest player (Biffa) having only a 10% national market share. Biffa is following the Republic Services playbook of tuck-in acquisitions to increase collection route density and utilization of waste disposal facilities (landfills, material recovery facilities / MRF and energy-from-waste / EfW power plants).
  • As Biffa increases scale it becomes a better and better business, generating higher operating margins and low cash flow volatility due to diversification and network effects.
  • Despite an open-ended runway for growth, Biffa trades at less than half the valuation of US peers. On NTM figures Biffa trades at 5.0x EBITDA, 9.0x P/E and 8.5% FCF yield to equity.
  • The people who the know the most are buying:
    • the CFO purchased 150,000 shares at 193p on 12/4/18, with smaller additional purchases in January.
    • Avenue Capital (Marc Lasry’s firm) increased its stake from 16.0% to 18.0% on 1/18/19 at 188p. 
  • The company is a no-brainer target for private equity. Biffa has an extensive opportunity set for reinvesting capital at high returns (tuck-in acquisitions, EfW) but is currently gated by the pace of its organic cash flow generation and self-imposed leverage limits (2.5x Debt/EBITDA). The business is a great place for financial sponsors to invest growth capital at (likely) higher leverage levels.

Business description: Biffa collects waste from businesses and municipalities and then disposes of it. The waste collection industry in the UK, similar to that of the US, is composed of collection companies, transfer stations, landfills, recyclers and incineration plants. Like the big 3 US firms, Biffa has a presence in all aspects of the industry, as the key to maintaining a profitable collections business is also controlling the means of waste disposal. Similarly, the key to maintaining a profitable waste disposal business is ensuring a steady stream of incoming waste volume by controlling a collections business. Collections businesses have high variable costs and relatively low fixed cost, hence the profitability of a collections business is 100% dependent on controlling the dominant variable cost: waste disposal fees. Things like landfill taxes or price spikes in landfill gate fees can ruin the economics of collection very quickly. By contrast waste disposal facilities like landfills, MRF, and EfW have high fixed costs and high incremental margins. The main risk is that incoming waste volumes are lower than planned and hence don’t cover operating costs. As a result, large waste players own both collection and disposal businesses to maximize profit since each side of the business is enhanced by the presence of the other. As waste companies grow sufficiently large in a municipal or regional context, they become better businesses as collections pricing power is enhanced and volatility of waste volumes decreases, enhancing utilization and margins on disposal facilities.

While the synergies between collection and disposal may seem obvious, Biffa presents its financials in 4 different operating segments which obfuscates the synergies between them. Most US waste firms break out revenue by activity, but Biffa presents revenue, operating profit and margins by activity, which has the unfortunate effect of generating analyst fixation on the volatility of individual business lines and overly complicated SOTP discussions. We believe this focus is not particularly helpful in understanding the business for two reasons. In the first place, Biffa’s own internal transfer pricing determines in which segment the operating profit sits. In the second place, the balance of power (profit) between collections and disposal can shift very quickly and while one looks better than the other today, that can change in the future. On first glance most people love the collections segment (I&C) but hate the disposal businesses (RR&T and Energy), although in reality these are just two sides of the same coin. We model the financials according to their segment disclosure like everyone else, but believe the business is best viewed as a whole, similar to the way people think about WCN, RSG and WM in the United States.

Collections business segments:

  • Industrial & Commercial: Picking up waste from small and medium sized businesses is the bread and butter of the industry. Volumes grow at real GDP (e.g. 1%-1.5%) with 2.5-3.0% price inflation = 3.5-4.5% organic revenue growth. As garbage pickup is an extremely small part of most businesses’ cost structure, customers tend to be quite sticky unless there is a service problem. 60% of revenues come from SMEs, 40% from corporates. Biffa’s collection volumes are relatively acyclical as they have limited exposure to the construction end market (e.g. homebuilding and nonresidential construction). The corporate market is increasingly moving towards segregated collections, which greatly benefits Biffa’s market share and win rate in the corporate sector as the industry’s largest player. Smaller competitors simply do not have separate trucks for collecting glass, cardboard, metals, food, etc as a function of scale.
  • Municipal: Of the 400 waste collection authorities in the UK, around 40% outsource their services. Biffa services 40 of those (25% market share) on multi-year contracts and generates revenue from collections (70% of segment revenue), street cleaning (20%) and ancillary services (10%). Given the size and multi-year nature of each individual muni contract, competition from small local players tends to be the most intense in this segment, resulting in lower margins. A mom-and-pop player can “live” out of a single contract and hence will bid very aggressively. Biffa is not growing in this segment and basically uses the volume generated to keep its disposal facilities in a given area full. As industry consolidation progresses, bidding in this segment will likely become more rational, as it has in every other jurisdiction with consolidated market share among waste contractors. To that point, Biffa management believes that margins have bottomed out in this segment in the last 6 months.

Disposal business segments: 

  • RR&T (Resource Recovery & Treatment): This segment includes landfills, hazardous waste disposal facilities, MRFs (recycling facilities), and soil treatment and composting -- essentially businesses where the collections companies send their waste. This segment is also the one most subject to government policy changes. Ten years ago the UK government massively increased landfill taxes, which made ownership of existing landfills a condition to surviving in the collection business as landfills simply passed on the tax via gate fees. Currently the UK government is actively working on policy to increase recycling activity, which will increase the profitability of MRFs via increased volumes. (https://www.theguardian.com/environment/2018/nov/11/retailers-to-pay-up-to-1bn-more-for-recycling-under-waste-strategy)
  • Energy: This segment currently includes landfill gas (85% of segment EBITA), the West Sussex mechanical and biological treatment plant (15% of EBITA), and two EfW power plants about to start construction. The landfill gas component is a ‘wasting asset,’ while the MBT generates stable profits. As such, segment profit should decline by ~7% per year until the EfW plants come online, which will generate 10-12mm in operating profit in 2022.

Uses of capital: one of the most attractive elements of Biffa’s business is that it offers management the opportunity to redeploy free cash flow at high-teens rates of return.

  • I&C acquisitions: Biffa has been purchasing small collections businesses at prices of 7x trailing EBITDA, 3.5x-5.0x post synergies. Basically Biffa buys a portfolio of local small business waste collection contracts in a given city, integrates the contracts into their existing route planning over a weekend, and shuts down the back office of the acquired business.The incremental EBITA margins on these deals is around ~18%, compared to the current segment margins of 8-9%. Biffa expects to generate around 4% organic growth in I&C collections, and 3-4% acquired revenue growth annually for low double digit segment EBITA growth
  • EfW plants: EfW plants in the UK are high margin, local monopoly disposal assets due to government tax policy favoring incineration over landfilling. These sites can take over a decade to receive planning permission due to NIMBY politics. Biffa has partnered with Covanta to build two new EfW plants in Cheshire and Leicestershire, with Biffa owning 50% of the equity in return for delivering waste volumes to the plants. 70-80% of EfW economics are gate fees charged to waste collection companies with electricity generation comprising the remainder. Biffa expects a high teens return on equity on their investment, and well-located plants receive utility-like valuations in the private market (high teens EBIT multiples).

We expect Biffa to reinvest its cash flow after dividends in both I&C acquisitions and the two EfW plants. Overall we see consolidated EBITA growing around 8-10% per year, excluding the 1x step-up in profit when the EfW plants come online. Upside exists in both the RR&T and muni business given that both are operating at trough levels of profitability. UK government policy initiatives to increase recycling activity via taxes on grocery stores and plastic bottle manufacturers could accelerate RR&T profitability. The reinvestment opportunity at Biffa is one of the aspects of the stock that we find most appealing. For most companies in most industries at this point in the economic cycle the incremental investment menu offers lower returns than the core business or previous investments. For Biffa, incremental I&C and EfW investments actually increase the value of the core business via scale. The reinvestment opportunity is why we think the company is/will be attractive to private equity - not only is the stock extremely cheap on the existing business, the company’s acquisition prospects provide an opportunity for incremental growth equity capital to compound at high teens returns.

On NTM numbers (fiscal year ending march 2020) we see the shares as being worth ~300p, approximately 70% higher than today. The implied valuation is 14x P/E, 6.5x EBITDA, 11.5x EBITA, 2.0x book value and 5.0% free cash flow yield. Basically we are arguing that Biffa should have at least a market multiple considering its defensive end market, open-ended growth profile and reinvestment opportunities. We acknowledge that the energy segment today is a 5.0x EBITDA business given the runoff nature of landfill gas profits, but this will change in 3 years once the EfW plants come online. On a 5 year horizon we think Biffa can grow EBITA to 140mm from 80mm today and command a higher multiple due to scale and higher margins -- yielding the potential for a 3-4x return in the equity. We tend to gravitate towards EBITA, as depreciation in the business represents a real cost; maintenance capex tends to equal depreciation.

All of the above begs the question: if this is a growing business in a defensive end market with the opportunity to reinvest capital at high teens rates of returns, why does it trade at a 9x P/E and below the 2016 IPO price? The answer is investor disappointment with the profitability of the municipal waste business, which has been reflected in both the RR&T (recycling volumes are primarily generated via municipal collections) and Muni segments. 

  • Mixed paper and RR&T:  investors were first upset with Biffa in March 2018, when it guided that fiscal 2019 EBITA would be flat to slightly up (rather than +8-10%) as a result of China’s policy of banning mixed paper imports. The Chinese government in 2017 banned the import of recovered mixed paper with greater than 0.50% impurities as part of their National Sword environmental campaign. Recovered paper is one of the recycled commodities that RR&T sells, representing £12mm per year in revenue. The commodity is an important input for manufacturing paperboard, much of which is made in China and used in packaging applications globally. As Chinese customs officials were not able to visually verify whether or not a given ton of recovered paper had the required 0.50% purity standard, they essentially halted all imports into the country by early 2018. Since China was importing 50% of all recovered paper globally, this change caused the price of mixed paper to drop to £0 or negative ex-China, while it skyrocketed within China itself as mills had to use virgin pulp to offset their lack of recycled feedstock. Biffa previously received £70/ton for recycling mixed paper, and they assumed in their profit outlook in March that mixed paper would trade at £0 in perpetuity. As it turned out in the subsequent nine months, mixed paper pricing rebounded to £30/ton, since supplies were simply rerouted to paperboard manufacturers in Southeast Asia and Chinese paperboard manufacturers purchased mills outside of China that could source mixed paper raw materials. Longer term we do not think this is an issue for Biffa, as the entire industry is repricing contracts with municipalities to have the commodity price fluctuations borne by the municipality rather than the recycler (currently Biffa’s contracts are a 50/50 sharing of price fluctuations). MRFs are currently running at breakeven for Biffa and generating losses for smaller players. Hence it is likely that the whole industry migrates to some form of cost plus regarding recycling collections, or else smaller players in municipal recycling are likely to simply exit the business.
  • Muni collections profitability: in November 2018 Biffa disclosed that the operating margin of its municipal collections segment was 2.5% for the half year as opposed to historical levels of 5-6%, and guided to this margin continuing in perpetuity. While the disclosure was a surprise to investors, the deterioration in front-book (new bidding) contract margins had been ongoing for some years as smaller collections players had been increasingly aggressive on bidding for new business. In the half year, a number of legacy higher margin contracts rolled off and the segment reported financials resembled the newer vintage contract margins for the first time. As management did with the recovered paper issue discussed above, they guided for low profit margins in the muni collections segment to continue in perpetuity, causing a number of investors to give up on the company. While management thought they were being conservative on guidance, many investors concluded that they were foolish for being in the muni business in the first place.
  • The reality is that, with municipal collections close to break-even profitability for the country’s largest waste collector and municipal disposal/recycling operations generating losses, many smaller waste companies are facing financial issues. The pain being felt at smaller players is causing municipal collection contracts to be repriced such that the local authorities are bearing the swings in recycled commodities going forward (rather than the waste collectors). Furthermore, the disruption is giving Biffa the chance to further consolidate the industry as mom-and-pop players struggle to make money and look to exit. The industry’s current troubles are sowing the seeds for a better industry structure in the future. On the whole we don’t think putting a trough multiple on trough muni/recycling profits is the right way to value the stock. In any event the company’s resilience is such that March 2019 fiscal year numbers incorporate two of Biffa’s segments operating at marginal profitability and the company still seems likely to post a small year-on-year increase in operating profits. Recycling is the centerpiece of UK government waste policy, and it’s likely that the industry will rebound over the next few years to the benefit of the scale players who are making the investments in processing capacity today.

Leverage: Biffa currently has 2.0x net debt / EBITDA. Biffa is planning on increasing leverage to 2.5x net debt / EBITDA to simultaneously fund both I&C acquisitions and the investment in EfW. US peers have the exact same leverage levels (2.5x), which is probably why Biffa management imposed the leverage cap at this level. US investors have historically been ok with this leverage, although in UK circles some describe anything above 2.0x as uninvestable. At a minimum, it’s a point of discussion. Leased equipment is capitalized, and the capitalized leases are included in the leverage metrics, so there is no hidden lease leverage here.

Brexit: We do not profess to have any foreknowledge about what the ending of this circus show will look like. Economically, the worst case is a “Hard Brexit” wherein the lack of pre-existing trade deals with third parties plunges the UK into recession upon the UK’s abrupt exit from the EU. Since Biffa is significantly under-indexed to the most economically sensitive parts of waste collection (e.g. the construction and demolition industries), we do not think that their core waste volumes are likely to suffer. On the contrary, Biffa is likely one of the only beneficiaries of Hard Brexit due to the industry dynamics around refuse-derived fuel (RDF) exports. Looking at a map of the UK, one can draw a rough diagonal line from Norwich to Bristol. The area to the southeast (which includes London) has sufficiently low transportation costs to make exporting packaged trash (RDF) to the Netherlands economically viable. The Netherlands has had an excess of incineration capacity for years (though it is tightening now). After the UK government radically hiked landfill taxes, trash exports became one of the lowest cost waste disposal option for parts of the southeast UK. This is the reason why landfills have struggled to command the same scarcity premium in the UK as they have in the US, and why incineration / EfW plants are quite profitable currently in the northern and middle part of the country (including Cheshire and Leicestershire) where RDF exports are less viable due to transportation costs. In the event of Hard Brexit, trash exports will suffer the same issues as any other UK export due to reversion to WTO rules, and suddenly owners of domestic landfill capacity, like Biffa, will find their assets in extremely high demand. Mothballed landfills will reopen and generate enormous profits. At the very least, we can say that no Brexit, Brexit-in-name-only, the current Withdrawal Agreement, Norway+, and a permanent customs union are all fine outcomes for Biffa, and they are probably the only public company that would explicitly benefit from a Hard Brexit.

In conclusion, we believe Biffa is a well-managed company with extremely strong growth prospects and a very cheap valuation. The issues in municipal collections and recycling that vexed the company this year are not structural in nature and offer the company opportunities to further consolidate the industry to its own benefit. If the market doesn’t recognize the ability to compound returns in this stock, it’s likely that private equity will. 

 

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Further I&C acquisitions

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    Description

    Long Biffa (BIFF LN): long-term compounder in the UK waste management industry. 70% upside to 12 month price target, potential for 3x return over 5 year horizon in a highly defensive end market.  

    Business description: Biffa collects waste from businesses and municipalities and then disposes of it. The waste collection industry in the UK, similar to that of the US, is composed of collection companies, transfer stations, landfills, recyclers and incineration plants. Like the big 3 US firms, Biffa has a presence in all aspects of the industry, as the key to maintaining a profitable collections business is also controlling the means of waste disposal. Similarly, the key to maintaining a profitable waste disposal business is ensuring a steady stream of incoming waste volume by controlling a collections business. Collections businesses have high variable costs and relatively low fixed cost, hence the profitability of a collections business is 100% dependent on controlling the dominant variable cost: waste disposal fees. Things like landfill taxes or price spikes in landfill gate fees can ruin the economics of collection very quickly. By contrast waste disposal facilities like landfills, MRF, and EfW have high fixed costs and high incremental margins. The main risk is that incoming waste volumes are lower than planned and hence don’t cover operating costs. As a result, large waste players own both collection and disposal businesses to maximize profit since each side of the business is enhanced by the presence of the other. As waste companies grow sufficiently large in a municipal or regional context, they become better businesses as collections pricing power is enhanced and volatility of waste volumes decreases, enhancing utilization and margins on disposal facilities.

    While the synergies between collection and disposal may seem obvious, Biffa presents its financials in 4 different operating segments which obfuscates the synergies between them. Most US waste firms break out revenue by activity, but Biffa presents revenue, operating profit and margins by activity, which has the unfortunate effect of generating analyst fixation on the volatility of individual business lines and overly complicated SOTP discussions. We believe this focus is not particularly helpful in understanding the business for two reasons. In the first place, Biffa’s own internal transfer pricing determines in which segment the operating profit sits. In the second place, the balance of power (profit) between collections and disposal can shift very quickly and while one looks better than the other today, that can change in the future. On first glance most people love the collections segment (I&C) but hate the disposal businesses (RR&T and Energy), although in reality these are just two sides of the same coin. We model the financials according to their segment disclosure like everyone else, but believe the business is best viewed as a whole, similar to the way people think about WCN, RSG and WM in the United States.

    Collections business segments:

    Disposal business segments: 

    Uses of capital: one of the most attractive elements of Biffa’s business is that it offers management the opportunity to redeploy free cash flow at high-teens rates of return.

    We expect Biffa to reinvest its cash flow after dividends in both I&C acquisitions and the two EfW plants. Overall we see consolidated EBITA growing around 8-10% per year, excluding the 1x step-up in profit when the EfW plants come online. Upside exists in both the RR&T and muni business given that both are operating at trough levels of profitability. UK government policy initiatives to increase recycling activity via taxes on grocery stores and plastic bottle manufacturers could accelerate RR&T profitability. The reinvestment opportunity at Biffa is one of the aspects of the stock that we find most appealing. For most companies in most industries at this point in the economic cycle the incremental investment menu offers lower returns than the core business or previous investments. For Biffa, incremental I&C and EfW investments actually increase the value of the core business via scale. The reinvestment opportunity is why we think the company is/will be attractive to private equity - not only is the stock extremely cheap on the existing business, the company’s acquisition prospects provide an opportunity for incremental growth equity capital to compound at high teens returns.

    On NTM numbers (fiscal year ending march 2020) we see the shares as being worth ~300p, approximately 70% higher than today. The implied valuation is 14x P/E, 6.5x EBITDA, 11.5x EBITA, 2.0x book value and 5.0% free cash flow yield. Basically we are arguing that Biffa should have at least a market multiple considering its defensive end market, open-ended growth profile and reinvestment opportunities. We acknowledge that the energy segment today is a 5.0x EBITDA business given the runoff nature of landfill gas profits, but this will change in 3 years once the EfW plants come online. On a 5 year horizon we think Biffa can grow EBITA to 140mm from 80mm today and command a higher multiple due to scale and higher margins -- yielding the potential for a 3-4x return in the equity. We tend to gravitate towards EBITA, as depreciation in the business represents a real cost; maintenance capex tends to equal depreciation.

    All of the above begs the question: if this is a growing business in a defensive end market with the opportunity to reinvest capital at high teens rates of returns, why does it trade at a 9x P/E and below the 2016 IPO price? The answer is investor disappointment with the profitability of the municipal waste business, which has been reflected in both the RR&T (recycling volumes are primarily generated via municipal collections) and Muni segments. 

    Leverage: Biffa currently has 2.0x net debt / EBITDA. Biffa is planning on increasing leverage to 2.5x net debt / EBITDA to simultaneously fund both I&C acquisitions and the investment in EfW. US peers have the exact same leverage levels (2.5x), which is probably why Biffa management imposed the leverage cap at this level. US investors have historically been ok with this leverage, although in UK circles some describe anything above 2.0x as uninvestable. At a minimum, it’s a point of discussion. Leased equipment is capitalized, and the capitalized leases are included in the leverage metrics, so there is no hidden lease leverage here.

    Brexit: We do not profess to have any foreknowledge about what the ending of this circus show will look like. Economically, the worst case is a “Hard Brexit” wherein the lack of pre-existing trade deals with third parties plunges the UK into recession upon the UK’s abrupt exit from the EU. Since Biffa is significantly under-indexed to the most economically sensitive parts of waste collection (e.g. the construction and demolition industries), we do not think that their core waste volumes are likely to suffer. On the contrary, Biffa is likely one of the only beneficiaries of Hard Brexit due to the industry dynamics around refuse-derived fuel (RDF) exports. Looking at a map of the UK, one can draw a rough diagonal line from Norwich to Bristol. The area to the southeast (which includes London) has sufficiently low transportation costs to make exporting packaged trash (RDF) to the Netherlands economically viable. The Netherlands has had an excess of incineration capacity for years (though it is tightening now). After the UK government radically hiked landfill taxes, trash exports became one of the lowest cost waste disposal option for parts of the southeast UK. This is the reason why landfills have struggled to command the same scarcity premium in the UK as they have in the US, and why incineration / EfW plants are quite profitable currently in the northern and middle part of the country (including Cheshire and Leicestershire) where RDF exports are less viable due to transportation costs. In the event of Hard Brexit, trash exports will suffer the same issues as any other UK export due to reversion to WTO rules, and suddenly owners of domestic landfill capacity, like Biffa, will find their assets in extremely high demand. Mothballed landfills will reopen and generate enormous profits. At the very least, we can say that no Brexit, Brexit-in-name-only, the current Withdrawal Agreement, Norway+, and a permanent customs union are all fine outcomes for Biffa, and they are probably the only public company that would explicitly benefit from a Hard Brexit.

    In conclusion, we believe Biffa is a well-managed company with extremely strong growth prospects and a very cheap valuation. The issues in municipal collections and recycling that vexed the company this year are not structural in nature and offer the company opportunities to further consolidate the industry to its own benefit. If the market doesn’t recognize the ability to compound returns in this stock, it’s likely that private equity will. 

     

     

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Further I&C acquisitions

    Messages


    SubjectRe: One comment
    Entry02/04/2019 05:34 PM
    Memberad17

    Mike,

    Fwiw, I am aware of the company's history. The reason that Biffa entered into administration was that it was levered 6x after the 2008 buyout, which proceeded to 10x leverage when the UK government hiked landfill taxes and Biffa’s collection business was over-indexed to landfilling as a means of disposal which crushed collection margins when landfill fees spiked. Given the company’s completely different leverage profile and ownership of disposal assets across the spectrum (landfills, MRFs and EfW), I would say that the situation is pretty/completely different today. Back then the UK government changed tax policy to incentivize more recycling and incineration, and Biffa was on the wrong side of things. Today the UK government is still trying to incentivize recycling, and given Biffa’ ownership of HPDE and PET processing assets, they are likely to be large beneficiaries of policy.   

     

    The use of the word “compounder” refers to the company’s opportunity to compound operating profit via reinvesting free cash flow into I&C acquisitions and EfW development. Maybe that word is overused, but the playbook of consolidating local waste businesses to achieve economies of scale has proven to be extremely effective in other jurisdictions, namely the US. The historical issues around leverage and changes in tax policy don’t negate the current opportunity. Frankly what interests me most about private equity’s historical involvement in Biffa is that they paid 23.5x earnings the last time the company was taken private.


    SubjectRe: Defensive Industry?
    Entry02/04/2019 06:39 PM
    Memberad17

    I would agree with your industry characterization for parts of Biffa’ business, specifically the muni segment today, but not for most of it. In a downturn overall volumes should fall in line with real GDP, although Biffa’s customers on the I&C side pay on the frequency of trash pick up and the number of locations rather absolute volume per se. An SME customer like a restaurant doesn’t pay Biffa 10% less if it generates 10% less trash. That restaurant is also unlikely to try to rebid its trash collection to a cut-rate service provider unless Biffa’s service has been an issue historically. People in the industry say rather glibly that theirs is the only business to business service where the customer literally doesn’t want to think about the service being provided (plus it's a relatively small cost for an SME anyway). People don’t pick up their phone to call their garbage company unless there is a service problem (it wasn’t collected), and then it’s a huge problem - so price is not the only determinant of the business. The key for Biffa’s I&C profitability is the route density of each collection truck since they charge “per container lifted”. It takes around 160 lifts per week to make 1 truck profitable. If they are the largest player in a city, they should be able to make money even when smaller players are breaking even just due to network scale. The SME collections business is primarily a variable cost structure - 70% of costs are waste disposal fees, wages, and fuel. The vehicles are usually leased, and the fixed back office costs are typically 10% of the total, so there is not a huge fixed cost to leverage.  On the national account / corporate side of I&C (40% of segment revenue) scale is the key to winning any business at all. Biffa provides service to 95% of UK postcodes and their closest competitor covers 65%, dropping off sharply from there. Biffa can also provide segregated collections (one truck each for different types of waste - glass, paper, food, etc) which small players cannot. The fact that Biffa is the one collections company with nationwide coverage does represent a difference between the US and the UK.

    The disposal side of the business is also different since people cannot simply add new capacity in landfills or EfW without decades of planning permission process. The UK hasn’t permitted a new landfill at all in 7 years. We haven’t seen irrational pricing on those type of assets in the US or the UK.

     

    The municipal collections business is very similar to what you described, and that’s why it’s operating near breakeven today - irrational pricing by small players. Muni contracts are typically 5-7 years in length, which creates very aggressive bidding by small players as a single contract determines whether or not they stay in business.  My understanding is that the US market was similar to this in the 1990s prior to consolidation.

     

    I think the I&C business is actually quite a good one at scale. The 2008 US experience in this industry was particularly noteworthy for the collapse in construction waste volumes after the unwind of the housing boom. Construction waste is overwhelmingly the most cyclical part of the industry, and apparently the most profitable in the good times. A few US companies were heavily exposed to these volumes, but Biffa is not. Biffa’s real cyclicality lies in the SME failure rate - if the UK were to go through a severe recession that saw a significant number of SMEs permanently closing, then one expect to see more churn in their portfolio which could entail contract repricing downwards. However, in this environment (similar to the UK muni business today), smaller competitors would be exiting the business and Biffa would pick up significant share.

     


    SubjectCompetition and regulation
    Entry02/05/2019 03:42 PM
    Membererst1071

    Thanks for posting such an interesting idea!

    1) Regulation

    How are landfill fees etc determined in the UK? Is it on a country wide basis or on a municipal area? Reason why I am asking is that in other European countries you have had some weird changes in regulation that has hit these markets very hard. Eventually it gets passed on to the consumer, but it takes time. Just trying to figure out how the market really works

    2) Competition

    You mention Biffa has 10% share. which companies are the next competitors? Are they as active in consolidating the market?

    40% of muni market is outsourced, what is the trend here? More being outsourced or shifiting the other way?

    3) Scale benefits

    You talk about scale benefits, but I am not sure how much economics of scale there is in this business. A garbage truck is full after a few streets and then have to return to depot. Is there any evidence of scale benefits on the collection side?

    4) Nov-18 muni collection

    You mention that smaller players are losing share due to the change, and that this will trigger further consolidation. What is your evidence for this? Where do you see margins of smaller players?

    5) Trash export risk

    China changing its policy on importing trash had a large impact on Biffa. Do we know how much of Biffa's revenue that is derived from either exporting or importing trash? 

    Thanks in advance!

     

     


    SubjectRe: Questions
    Entry02/05/2019 04:22 PM
    Memberad17

     

    Lohengrin,

    I would (obviously) be quite surprised if Biffa needed to issue equity in the future. Their current EBITDA is a little over 150mm, and their net debt is ~300mm. The three year cumulative investment in EfW is 75-80mm for both plants. So basically all they have said is that borrowing to fund the EfW total investment would add 0.5x leverage over the next three years on today’s profits. Clearly, they plan to grow those profits over the next three years but I suppose that is the subject of debate.

     

    Historically recycling has been the most cyclical component of the business as the recycled commodity prices drop off in a recession. Today those prices are already at all-time lows (worse than prior recessions) due to the Chinese national sword policies, so it seems unlikely that they would deteriorate from current levels. I would argue that recycling is likely to improve even in a bad economic environment as the UK moves to encourage more use of recycled plastics in milk and drink bottles which benefits Biffa. Municipal collection contracts are breakeven to loss making for Biffa’s competitors, so they are also unlikely to worsen from here in a recession from a pricing perspective. Household waste volumes have been resilient in the UK. During 2001-2002 they didn’t move at all. During the UK’s worst recession in living memory (2008) household waste volumes fell at a 2.3% CAGR for 5 years, for a 12% cumulative decline before resuming growth. However, the volume wasn’t really an issue as much as people's’ assumptions around disposal costs and recycling profits. Hence I do not see muni price or volume as significant risk. Given the resilience of household waste volumes, landfill and EfW economics are also likely to be unchanged.

     

    So the question remains about I&C profits. As noted previously, the most volatile component of the industry by far is construction waste, where Biffa has minimal exposure. Outside of construction, waste volumes haven’t seen much volatility, due in part to the growing number of statutory waste directives like food waste collection, electronics collection, packaging collections, etc. Small declines in volume are actually great for Biffa as collecting 5-10% less waste for the same customer is actually more profitable. They get paid per weekly lift (which doesn’t change for 5-10%) but incur disposal fees on a per ton basis, so small declines are pretty good for them. In a recession there would be an acceleration of SME contract churn for all players, as some businesses would fail and others open. There is not much decline in total waste volumes ex-construction so the volumes in a given city see some redistribution among the customer base. Biffa has 10% annual churn today in the SME segment, versus the industry at 30%, which speaks to their operations and customer service. I think one could make the case that Biffa will do a good job of taking market share in that environment based on service. My understanding is that weekly charges per bin are between £12 and £18 for an SME customer. The small waste players that Biffa acquires operate at 10% margins (prior to synergies), so if those players decided to operate at breakeven and cut price by 10% it’s only a £1.20 to £1.80 savings per week for the SME. I don’t think a business owner would take the risk of garbage not being collected by choosing a financially shaky local trash collector for savings of 1.80 per week.

     

    Essentially, the I&C business has been pretty resilient for Biffa historically and I would think that will continue. The volatile segments like recycling are already at a trough. Plus Biffa should continue purchasing local I&C players which will add EBITDA each year to the current 150 rate. If I’m wrong on the resiliency of the business and things did deteriorate, my guess is that they would slow their I&C acquisition pace rather than issue equity, and then restart after they started receiving the profits from EfW. I’m reasonably confident in the EfW profit stream because the primary risk to those plants is insufficient waste volumes, and Biffa controls those volumes.

     

     

    Regarding aggressive bidding in muni contracts, my understanding is that this phenomenon was the result of some newer players in the market not fully understanding the risks being taken on waste disposal, combined with some overly optimistic assumptions regarding recycling volumes and price assumptions. For longer dated contracts that include both local collections and the operation of single site MRFs (e.g. facilities that only process recycling from one municipality), peoples’ estimates regarding the amount and profitability of recycling were pretty wrong in the last decade. Now that some of the risks are better known, both pricing and terms and conditions on muni bidding are improving. For muni, I would think that the concept of scale is not so much on the collections side (given winner-take-all on the collections) but rather in better controlling disposal costs via ownership of local landfills, EfW, etc.

     


    SubjectRe: Tangentially related
    Entry02/05/2019 05:31 PM
    Memberad17

    Unfortunately I don’t know anything about Estre, or what went wrong in Brazil. I can only surmise that Avenue thinks that the stock has value but I don’t know if they have any particular plans.


    SubjectRe: Competition and regulation
    Entry02/05/2019 09:30 PM
    Memberad17

    My understanding is that UK landfills have regulation at the national level around permitting, types of waste accepted, taxation on waste accepted, and aftercare costs. I believe this legislation is aligned with the EU directives on those subjects, at least currently. I have not heard of specific regulation on landfill fees, as I think those are determined by market forces & distance from waste collection areas. However, the concept of market forces is muddled by interferene from tax policy, as landfill taxes have favored recycling, incineration and (unintentionally) RDF exports as lower cost disposal options. The huge hikes in landfill taxes changed the waste disposal landscape starting in 2006 through 2015 or so. I could definitely be wrong this, just saying that I have not heard of specific regulation on fees before.

     

    After Biffa the next biggest are Viridor, a local subsidiary of Veolia, and a local subsidiary of Suez. Viridor has been primarily focused on building a portfolio of EfW plants rather than collection businesses, and I haven’t heard much about Veolia or Suez, which are around a fifth of Biffa’s size. For whatever it’s worth, Biffa management has been saying that they haven’t lost any acquisition targets that they wanted, and haven’t had to change their acquisition pricing. Regarding trends in outsourcing by local authorities, I’m not sure. Biffa’s focus for the next few years is on acquiring additional scale in the commercial business rather than winning new muni contracts. My main point on the muni business is that it has likely troughed, not that’s a significant growth driver on new contracts in the near future.  

     

    The waste collection companies all talk about route density as the key to profits on I&C collection - it’s a function of how many container lifts a given truck does in a week. If you’re a small player with SME customers spread out over greater Manchester, it’s likely that the collection trucks are driving all over town as part of their route. If you have 20% market share, odds are that a number of the customers are located close to each other and you can use route planning software to optimize the collection routes and minimize time between lifts. The density of the route gives the truck many more lifts per week than the smaller player, which is where the economies of scale are realized. There is also leverage on higher utilization of the same sales and support staff over greater numbers of customers in a region but that’s a smaller impact. Finally, if you also control the main disposal sites in the region you can also ensure that your sites have as much utilization as possible from your collection business. As far as evidence, I haven’t seen private company financials but Biffa or Viridor might be able to give you information on the differences in per route economics between them and smaller companies.

     

    A number of players are currently losing money on muni contracts, given issues on the waste disposal side and insufficient collection margins to make the whole contract profitable. This feedback simply comes from conversations with people who work in the industry. My assertion is that pricing, terms and conditions, or both will improve in muni contracts to make them more profitable because most people are losing money today. Biffa has other profitable segments to their business, while smaller players trying to survive on a single muni contract most likely do not. Apparently bids on basic collections are not the issue per se, it’s the rebates/volumes or other features of the disposal side of the business combined with tight collection margins that got people into trouble (i.e. our contract bid assumed that recycling prices of X would need to prevail for the next 7 years for us to make money). I do think longer term the industry structure in the muni business will be better when there is consolidation of ownership on disposal assets for a given area, just not in the near future. However I think Biffa's muni segment can report improved performance from current levels regardless.    

     

    Biffa had 12mm of revenue, 6mm of EBITA from exporting mixed paper that was at risk from national sword. That revenue and profit largely disappeared from Feb-June 2018 when pricing on mixed paper went to zero. It’s come back a bit now with pricing at 30-40/ton.


    SubjectFew questions
    Entry02/15/2019 09:23 AM
    Memberhumkae848

    Thanks for the great writeup.  I was hoping to get your view on a few things whenever you had the chance...

    1.  Have you ever tried to quantify the amount of revenue/EBITDA that is ultimately derived from commodity prices (recycled plastic, mixed paper, cardboard, electricity prices)?  From my preliminary work, it would seem that all of energy and a subset of RR&T would fall into this category.  I'm just curious if you ever tried to quantify more scientifically and how you thought about that exposure in light of what the proper valuation multiple is for this business.

    2.  This is more of an ignorant question, but over the years, I've read on several occasions of failed efw projects in the UK.  Air Products is one that I remember back in 2015/2016.  Also, Interserve and Carillion, more recently.  Just curious how you think about the risk of approval, construction, and overall feasibility for Biffa's two projects.

    3.  As I think about the growth profile over the next several years, it's reasonable to assume I&C will continue to grow both organically and via acquisition. Municipal profitability should hopefully improve slightly, but clearly this is not a growth segment.  How do you think about the growth profile of RR&T and Energy (excl efw)?  I'm having trouble thinking about how landfill profitability will trend going forward.  Does it decline over time as they run out of space, or does pricing offset that?  And is there a lot of untapped capacity in their MRFs such that profitability will inflect should there be an increase in volumes (helped by the government)?  And would Energy EBITDA decline gradually in the absence of those efW plants?

    Thanks so much.  Would love to hear your thoughts.      


    SubjectRe: Few questions
    Entry02/16/2019 03:39 PM
    Memberad17

    We view the MRF subsegment of RR&T as the part of the business exposed to commodity prices. It currently generates mid-single digit negative EBITDA on the trailing ~150mm of company wide EBITDA for the year ending March 2019. The MRF outputs are mixed paper (50% of recycled commodity volumes), glass (20%), plastics (15%), metals (5%) and residual waste of ~10%. These commodities are globally traded / exported and have been the focus point of the turmoil around National Sword in China. MRF economics should return to breakeven in the next 12 months if only as a result of Biffa hiking gate fees, renegotiating recycling contracts to more cost-plus terms and the price of UK mixed paper stabilizing at 30/ton after being at zero this year. The rest of RR&T is composed of landfills, HDPE, and aggregates - all of which have good profit generation. Biffa’s landfills are seeing good growth and pricing power since the UK hasn’t approved a new landfill in years and competing sites are closing. Their HDPE plant is the only food-grade approved milk carton recycling asset in the country, with 18% national market share on HDPE production and demand for 2x what they are currently producing. Given the huge amount of regulation around permitting and approval of new food-grade assets, the HDPE is basically a local utility. Aggregates refers to soil treatment facilities that produce aggregates like that of VMC, MLM as an end product. Essentially everything else in RR&T except the MRF business commands a 10x+ EBITDA elsewhere in the markets, and we are not forecasting the MRF to ever do better than breakeven... although that could quickly change if UK policy incentives more use of recycled materials via tax policy.  

    85% of energy is landfill gas, which is a business in runoff. We basically DCF landfill gas over 15 years at an 8% decline. The DCF value implies a 5x EBITDA multiple on current profits, which seems reasonable. When the EfW assets come online in 3 years, we use a 10x multiple on that profit stream since these are basically utilities with 75% of economics from gate fees and 25% from electricity generation . London EfW assets have gotten a 15x multiple in private transactions. Given that Biffa controls the waste stream, and incoming waste volumes determine EfW economics, we would expect very little volatility of EfW profit over time. I'm using EBITDA in the discussion below for comparability with US waste firms.

    86mm I&C EBITDA: 10x multiple (vs US peers at 12-13x, Biffa with lower margins but better growth prospects)

    33mm of energy EBITDA: 5x multiple (DCF derived)

    30mm of RR&T (of which MRFs are -5mm, a very rough estimate) EBITDA: 10x multiple per the above

    17mm Muni EBITDA: 5x multiple because everyone just hates this business

    =166mm segment level profits, weighted average of 8.5x EBITDA

    -14mm central overhead costs, assumed same 8.5x EBITDA as above.

    =152mm EBITDA for March 2019

    US waste peers trade at 12-13x on consolidated EBITDA, which is composed of business that resemble I&C, Muni, and RR&T. Since US firms don’t break out commercial collections versus muni collections versus recycling profits, people generally don’t do SOTP on them but just look at the whole. Investors penalize Biffa on the multiple because they do break out segment profits, which gives people the chance to slap low multiples on segments they hate, like the muni business. Our near term price target of 300p implies a 6.5x EBITDA multiple, but we think that the overall business will eventually trade at 10x multiple in a few years as I&C increasingly dominates the total (e.g. a modest discount to US peers).

    Biffa is building the EfW under EPC style-contracting, where the contractor is responsible for design, procurement, construction, and commissioning of the facility. Basically they are not taking cost-overrun risk unless the contractor were to go insolvent; I would imagine that they are picking one with a strong balance sheet given issues with Carillon, etc. Viridor had this exact issue with Interserve on their Glasgow EfW facility, but the main difference is that Viridor was attempting to implement new gasification technology which encountered some technical issues (to say the least) and Interserve itself had a number of their own problems. Biffa is using a traditional moving-grate incineration process, and their partner Covanta has built and operated something like 40 of these plants around the world. They already have all the approvals and permitting done, so the main risk is that Covanta totally fails on plant design and construction, which is their core business. I confess to not being particularly concerned about this but if one were to be, then you could always short CVA as a hedge. They trade at 10x EBITDA fwiw.

     

    Muni EBITA margins should be 3-4% in a steady-state but I wouldn’t expect revenue to grow from here, just a slight rebound in EBITA. Energy should decline around 7% per year given the 15% of the segment represented by MBT is not in decline. The 85% related to landfill gas declines to zero over a long period of time. In 3 years Biffa will add 11-12mm of annual pre-tax profit in the form of distributions from the EfW assets, which grows over time as the EfW pays down project finance debt. Over three years energy EBITDA decline from 33mm to 26.5mm, but then increases due to the EfW. RR&T should rebound by 5mm as the MRFs move to breakeven but from there we have it basically growing at inflation levels. Landfills will eventually run out of capacity but those profits are going to be replaced by investments in things like PET recycling, further lines on HPDE, possible glass purification & sorting plants etc. The main growth driver is I&C. If the UK government actually moves towards encouraging more recycling, RR&T profit could be enhanced considerably via higher recycling commodity prices but we are not modeling this.


    Subjecthedging the pound
    Entry02/25/2019 06:12 PM
    Memberhumkae848

    thanks so much for your earlier reply.  very helpful.  i'm not sure if you are a $-based investor, but was asking the following question, just in case you are...  how did you go about hedging the british pound?  


    SubjectI&C acquisition announced
    Entry03/12/2019 08:41 AM
    Memberad17

    Last night Biffa announced the acquisition of SWRN, which is a broker serving the national & regional accounts segment of the I&C collections market. For context, when Biffa has historically competed in the national accounts collections business, it has typically been them plus a couple of large, "credible" waste brokers, one of which is SWRN. The brokers don't have physical assets but subcontract out the collection service to firms like Biffa; Biffa in fact handles 11% SWRN's current volumes. National accounts are firms like hotel chains, restaurants or retailers with locations that need trash collection spread out across the country. We think this is a great deal for Biffa, as it takes out one of their top competitors in this segment and increases collection density across all of their markets simultaneously - instead of buying a local collection business in a given market like Birmingham and having better scale in that market specifically (which, to be clear would, be a good thing), they bought a firm that adds collection volumes across the entire country. The deal is accretive to both margins and returns on invested capital immediately. The deal is also accretive to EPS, adding 40.1mm in revenue (35.7 ex Biffa), 3.4mm in trailing EBITA and 5.3mm EBITA pro forma for back office cost savings on a purchase price of 25.8mm. Over time, as they grow national account collection volumes the deal will be further accretive by increasing asset utilization at the local level. 


    SubjectRe: I&C acquisition announced
    Entry03/13/2019 12:14 PM
    Memberhumkae848

    thanks for the update, interesting acquisition indeed.  

    i was hoping to get your thoughts on landfill:

    From where they stand today, they have about 10-11 years remaining on their landfill sites.  Practically speaking, what is your view on what happens here?  There are interesting dynamics with the RDF exports becoming more expensive, but it doesn't seem like that will provide any meaningful tailwind to landfills, especially if more EfW plants are built.  Does cash flow fall off a cliff in 10 years time?  How do you think about valuing this stream?  Is it appropriate to put a multiple on this business?

    Also, from an after care point of view, does it make sense to treat the provision on the balance sheet as some type of debt? 

    Thanks in advance.


    SubjectRe: Re: I&C acquisition announced
    Entry03/14/2019 08:58 AM
    Memberad17

    The landfill topic is interesting because it touches on overall UK waste policy. As it stands today, the volume of UK waste isn't dropping, but Biffa has noted that a number of other landfills are closing (on account of being full) and there is no other current means of disposing of certain types of "inert" waste. Inert waste is stuff that is neither good for recyling nor for incineration (EfW or RDF). In theory in 15 years the landfills just run out of space and then certain types of trash have literally nowhere to go - so obviously the status quo is not a realistic option and the disposal market is likely to change. Everyone has opinions on how exactly things will shift. My two cents would be that as landfill capacity becomes increasingly strained, prices will go significantly higher, which will prompt Biffa and others to re-open currently mothballed or remote landfills to meet the volume. Most likely the government will also change tax policy to significantly increase recycling volumes in order to further shift volumes away from landfills to reserve that space for the types of trash that really cannot go anywhere else. So my guess is that "years of remaining life" will be revised higher for landfills, as prices rise and volumes fall, while profits and volumes on recycling will increase significantly. So I do put a multiple on landfill profits as I think they are likely to continue for longer than current run-rate volumes would suggest.  

    I view the landfill aftercare obligations as an operational liability, similar to pensions or long-dated operating leases. We obviously include the payments on landfill obligations in our calculation of free cash flow, but given that the landfill payments occur over the next 60 years and cannot be accelerated to my knowledge, I haven't spent a ton of time worrying about them. They obviously matter in an insolvency scenario, but a number of other things would have had to have gone dramatically wrong first before these became the primary issue. 

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