Stockwatch: Profit from the crusade against plastic

Does public angst about plastic herald a major growth opportunity for Biffa, the UK's leading waste management group listed in the Mid 250 index?  

Its chief financial officer who is stepping up to the chief executive role, plans to ramp up recycling of plastic bottles, arguing Biffa is well-placed and public sentiment against plastic is likely to intensify.  

A fresh flavour to the story is needed otherwise prelims to 30 March 2018 are a curate's egg: the industrial & commercial side faring well if boosted by an acquisition, while municipal activities see margin pressure as local authorities tighten terms for bin collections.  

There's still a long-term growth theme in the UK generating more combustible waste than it has facilities to cope, if disrupted earlier this year when the Chinese tightened import regulations on recyclable commodities - a key disposal route for UK waste firms.  

Biffa shares plunged from just shy of 250p to about 200p for a couple of months, recovering ahead of the results and currently sitting at around 240p.

Source: interactive investor      Past performance is not a guide to future performance

Market versus private equity valuations 

This capitalises Biffa at around £600 million, which compares with a £1.7 billion tag in a leveraged buyout by Montagu Private Equity in 2008.  After founders sold out in 1971, there have been various owners from industrial services group BET then water company Seven Trent which embarked on an acquisitions strategy.  

Within two years, Montagu had flipped the business to another private equity group and three years later in October 2016 it was re-floated at 180p i.e. £450 million.  

I cite all this on a cautionary note because, if a lead market position in waste management is such a virtue, why are serial owners flipping than holding Biffa, and how come a markedly reduced value over a decade?  Yet it's impossible to know what disposals, private owners may have made along the way, providing an element of unrecorded gains.  

Acquisitions continue, with seven completed in the last financial year. A "strong pipeline of opportunities" is also cited versus end-March cash of £40.8 million and a total £176.5 million undrawn credit facility relative to £359.7 million existing debt, mostly long-term.

It's a fairly typical story of a listed plc boosting performance with acquisitions and debt, hence it would benefit from an organic growth kicker.  

Upside from long-term dividend growth potential

Meanwhile, dividend prospects may tip risk/reward favourably.  Achieving underlying earnings per share (EPS) of 19.2p versus statutory of 12.4p (slightly ahead of the 4 May consensus for 18.4p, underlying,) makes the 19p forecast for 2019 based on £64.5 million normalised pre-tax profit, look undemanding.  

Against this, a sub-3% yield barely offers technical support, although the cash flow statement shows a 93.3% jump in cash generated from operations to £142 million, implying potential to re-rate a dividend that only absorbed £11.3 million of this.  

In the short term, however, the board will be mindful how net cash used for investment rose 35.3% to £78.9 million, with £47.1 million spent on acquisitions last year and an objective to spend £25-30 million a year buying more.  

But, if strong cash flow is maintained, then in future years the board should be able to at least double the payout, e.g. scope currently to lock in a 6%-plus yield, and which implies capital upside over time – the price rising if the market perceives a lower yield is appropriate for overall risk.

Source: Company REFS            Past performance is not a guide to future performance

Plastics' potential, if still early-stage

Don’t hold your breath scouring for plastics in the latest operating review; the only reference is courtesy of Biffa Polymers in the performance summary for the Resource Recovery & Treatment (RR&T) division that enjoyed an 18.1% rise in underlying operating profit to £13.7 million.  

As yet, that's just 16.9% of group total, on a modest operating margin up from 5.8% to 6.2%.  Way to go then, for plastics to provide much boost, although Polymers' expansion only completed in March 2017.  RR&T also involves landfill of unrecyclable waste (where the UK is closing sites), and is where changes in Chinese regulations for imported waste hit earnings, likewise price falls in recycled materials.  

Biffa Polymers actually goes back to 2008, offering a revolutionary process for milk bottles, and won a Queen’s Award for Excellence in 2010.  Then, in 2011, it opened the world’s first mixed plastics plant to deal with consumer packaging, diverting it from landfill and enabling plastic compounds to be re-used in wide applications.  

A second treatment/recycling plant has been completed, thus Biffa is at least positioning itself well, despite the financial upshot from plastic being premature to guess.  Meanwhile, is the stock's risk/reward profile adequate to buy in the hope of getting lucky, both for income and plastics' growth?

Mixed progress for a strategy of growing market share

Underlying group operating profit is up 10% on net revenue up 8.8%, helped by acquisitions, or 4.4% like-for-like benefiting from new commercial customer wins.  

The acquisitions’ strategy is not just to enhance profits: Biffa contends rising customer demands favour consolidation of supply chain logistics, especially on the Industrial & Commercial side, thereby achieving cost/revenue synergies and explaining its being 59.2% of group operating profit.  Mind, this has also built up goodwill/intangibles on the balance sheet near 100% of net assets.

The Municipal side, collecting bins for local authorities, has had margins squeezed – affirming a sense of outsourcers under pressure – thus its operating profit is down 15.4% despite revenues up 9%.  

"A disciplined approach to capital allocation and tendering will mean revenues are likely to decline 6-8% in the coming year, with margins expected broadly stable."  This may help explain a cautious approach to 2019 forecasting, although Municipal accounts only for 10.7% of underlying operating profit i.e. presents no major swing risk to totals.  

Energy has also declined 6% in profit to 34.6% of group total, on near-flat revenue, said due to some non-repeating items in the prior year distorting the comparison.  Yet this division re-iterates a sense of mixed performance in the overall narrative: a reduction in landfill gas generation largely offset by stronger electricity and renewables’ recycling prices. 

A glass half-full mindset could pay off

Backing Biffa amounts to whether you are prepared to tuck its stock away on the basis that near-term challenges will be overcome by efficiencies from acquisitions and investment. Plastics are a shrewd area for development, if speculative, as a financial game-changer.

Meanwhile, the present yield is no great return, but has scope to genuinely improve, hence push the stock up too.  The business should not be adversely affected by Brexit or, indeed a UK slowdown.  Market forecasts already look complacent for 2019.  For the long run therefore: Accumulate.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.