Friday, April 12, 2013

Casella's Mixed Bag

Solid waste has been one of the business types that has a natural hedge against macroeconomic distress.  No matter how bad things get, as long as our neighbors draw breath there will be trash to handle.  Casella Waste Systems, Inc. (CWST:  Nasdaq) sits in the shadow of larger waste handlers such as Waste Management (WM:  NYSE) and Republic Services (RSG:  NYSE).  Consequently, it is often passed over by investors despite a significantly better profit margin.

One of the reasons investors might not take Casella seriously is its history of net losses.  However, the bottom line is only part of Casella’s story.  After hitting peak sales in 2007 and then suffering the effects of recession, the company has delivered successively higher sales in each of the last four years.  What is more Casella generates strong cash flows  -  enough to cover capital expenditures.

So now that I have started ‘bull’ case for CWST, I have to let investors down a bit.  Casella’s profit margins have been eroding.  Even as sales began to recover in fiscal year 2010 (ending April 2010), higher costs began to nip away at profits.  The gross profit margin was 28.4% in the nine months ending January 2013.  This compares with 31.9% in the same period of the previous year.  The profit margin peaked in fiscal year 2010 at 33.7%. 

Protracted economic stress has also shown up on the Casella’s balance sheet.  The company’s financing interval has been deteriorating over the last four years.  Mind you, Casella gets more than enough credit from its suppliers to cover capital requirements for inventory and accounts receivable.  Indeed, payables days have consistently exceeded the sum of inventory and account receivable days.  The problem is that the cushion diminished dramatically over the last few months.  It could be a temporary situation or the signal of a new business reality for Casella.

Casella’s waste disposal and recycling services for municipalities have put the company in line for favorable financing.  Its most recent financing was accomplished through the sale of $5.5 million in solid waste disposal revenue bonds that will bear interest at the rate of 0.2%.  We expect such arrangements to remain a small portion of Casella’s total debt.  Nonetheless, it will have the effect of reducing total interest cost.

It is a mixed bag of analysis, but it is a cheap bag.  CWST has a negative price/earnings ratio because of net losses.  However, on the basis of cash flows, the stock looks very attractive.  The waste management group trades at 11.7 times cash flow, but Casella is on sale for 3.8 times CFO.  Casella does not pay a dividend so any investors taking a long position in CWST must count on price appreciation.  Unfortunately, the stock has exhibited little upward momentum in recent months.  Thus the stock might be cheap, but realizing a gain from this bargain will require patience and plenty of time to wait for price recovery.

 
Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

 

No comments: