Casella Waste Systems: Trash Is King, But This Valuation Just Stinks (NASDAQ:CWST)

Introduction

I’m a big fan of the trash business. Waste management and waste collection is a high margin, recurring revenue business model that’s typically been resilient to weaker economic periods while putting up steady top line growth from volume growth year after year. However, I’ve learned one thing from studying the waste management industry is that not all companies in the space are created equal and there’s a wide range in terms of the multiples one can pay across the peer group.

From the last time I reviewed Casella Waste Systems (NASDAQ:CWST), the company was trading at the higher end of the valuation range of its publicly traded peers like Republic (RSG), GFL Environmental (GFL), Waste Connections (WCN), and Waste Management (WM), but the market was assigning it a higher multiple given it was much smaller than the rest. In theory, this would imply higher growth potential, particularly given the focus on the Northeastern United States in places like Massachusetts, Maine, New Hampshire, New York, Vermont, and Pennsylvania.

Since my last review in February when I analyzed the company’s Q4 and full year 2023 results, volumes at Casella were down while pricing was up, resulting in a miss on both revenues and EPS. With the latest Q2’24 results announced just this week on August 1, I’ll provide an update to my investment thesis to see if shares are finally a buy today.

CWST Q2 Results

In Casella’s second quarter 2024 results, the company reported a beat of $5 million in revenue, as sales clocked in at $377 million, up 30% on a year-over-year basis. While revenue beat analyst estimates, EPS fell short, with earnings per share missing analyst estimates of $0.28 by 6 cents.

What led to the results? Perhaps the biggest standout is the huge jump in collection revenues, from $150 million last year to $224 million in this year’s quarter. Most of this was a result of acquisitions, as during the first half of the year when the company acquired one business, a tuck-in solid waste collection businesses in the Eastern region. Last year, the company also acquired four subsidiaries from GFL Environmental, which has also contributed to the growth in the top line.

M&A hasn’t stopped there for Casella. Subsequent to the quarter, the company just announced the acquisitions of LMR Disposal and Whitetail Disposal in the Mid-Atlantic, which I believe should densify the company’s existing footprint and help it expand into new markets. This puts year to date deals at 5 total transactions, which have been primarily funded with cash. Management notes that synergies should come primarily from improving fleet and internalizing recyclables (but not waste).

From a balance sheet perspective, Casella has leverage of approximately 2.9x with the new deals (my calculation) or 2.6x at quarter end. Most of the debt matures beyond 2029 and is financed at low rates around the 5% level. So, while debt is elevated, the interest rates aren’t too high, likely due to the resilient and predictable nature of the business model. On free cash flow, no change has been made to the outlook as higher earnings contribution was offset by increased interest expenses and a more subdued outlook on working capital.

On pricing and volume, Casella’s pricing is ahead of its plan, as inflation has remained stickier than expected. Given cash flows are somewhat indexed to CPI, Casella (and other peers within the waste management industry) have been beneficiaries. Across the business, Casella sees inflation of around 5% in the business. From a cost perspective, pressures have eased in labor but remained sticky for R&M and Landfills. The spread between price and cost in the base business has consistently been above 100bps, and, in my view, will be key to monitor this going forward to ensure that Casella can sustain its margins. With respect to the outlook, Casella revised its outlook for solid waste volume to be down 1%-2% for FY’24 vs prior guidance of between flat to down 1%, driven primarily by continued softness in collection and disposal (C&D) tonnage. Regarding this revision, management has noted that it is facing C&D volume pressures as Brookhaven Landfill in Long Island has been chasing C&D volumes aggressively before it closes at the end of the year. Management expects C&D to recover in 2025.

In the recycling business, Boston MRF is performing better than expected post upgrades and contributed $3 million of AEBITDA growth in Q2’24. So far, results have been accretive to EBITDA on a margin and dollar basis. At Willimantic MRT, a similar upgrade is underway, so my view is that we should expect an additional EBITDA lift from here; however, management didn’t provide a timeline on this. Across the recycling business, the average commodity revenue per ton was up a whopping 50% year over year in the second quarter, but the net impact is negligible at $1 million due to SRA contract structures working to reduce commodity volatility. In the back half of the year, management has said that they see favorable comparisons year over year as current commodity prices remain above where they were in the second half of 2023.

To me, one of the issues that concerns me about Casella is on the company’s guidance. While Casella’s management says that they’re confident in the full-year free cash flow outlook, Q1 and Q2 represent less than 30% of FY’24 guidance. In my view, with the stock trading close to all-time highs and expectations being revised upwards by most sellside analysts, I view this to be a risk. A lot hinges on Casella’s expectation for a better second half than what we’ve seen January through June.

Moreover, with the acquisitions that were announced, leverage has crept up to just under 3x now on a pro forma basis, so it’s likely that acquisitions might be on pause for the near future. As such, I’ve become more cautious than I was in February, when I initially thought that acquisitions would be enough to hit guidance targets. Two quarters into the year, the risks are now elevated in my view.

Valuation and Wrap Up

Analyst ratings can generally give a good indication as to what kind of expectations are being baked into the stock. At present, there are currently 9 sellside analysts who are covering Casella’s stock. A third of them have ‘buy’ ratings, with 2 maintaining ‘hold’ ratings and just one ‘sell’ ratings. Despite majority ‘buy’ ratings, analysts have been cautious on raising their price targets, likely due to valuation. From the current price to the average analyst price target one year out, this is implying upside of just 1.7%. With no dividend to supplement, I’d say that shares are likely fairly valued at best here.

It’s not just the analyst price targets that influence my analysis. When we look at the company’s valuation, we can see that with the recent run-up in shares, Casella is trading well above its historical ten-year multiple of 15.8x EV/EBITDA (source: S&P Capital IQ). Pre-COVID, this was a business one could buy for 9-15x EV/EBITDA, but given that the story has become more discovered and now trades above peers (and no longer below), I’d say investors’ expectations on free cash flow and earnings growth have been more than reflected into the stock price. Moreover, revenue is expected to increase at an 8.2% CAGR into 2028, so the valuation appears to be fair (source: Bloomberg).

In summary, I think Casella has a unique position by operating and the Northeastern states, and the latest acquisitions highlight a willingness to grow outside of that. With the latest quarter behind us, I worry that the company might not be able to hit its guidance targets, which might be the reason the company has been spending so aggressively in M&A. Overall, with the company trading at a substantial premium to its historical average multiple as well as its waste management peers, I’m inclined to avoid shares of Casella for now, seeing better opportunities among higher quality competitors like Waste Connections. You can find my previous coverage of Waste Connections here.