Fri, Jul 8, 2016

Dirty Business

'Where there’s muck, there’s brass’ goes the proverb about making money from what is sometimes viewed as an unpleasant activity. Dealing with the UK’s circa 200 million tonnes of waste has arguably fallen into this category, but how does the old saying hold up?

On the face of it, an existing waste processing business can appear attractive for a funder. High barriers to entry and long term contracts, often combined with blue chip or local authority customers, provide a stable and predictable revenue stream. However, dig a little deeper and things are a lot less clear.

The main influences on the sector have largely come from European legislation designed to reduce landfill and improve recycling rates amongst member states. One of these measures was the Landfill Tax which was first introduced by the government in 1996. From 1996 to 2007 the cost per tonne increased from £7 to £24, and it now exceeds £84.

Whilst during the last couple of years we have seen only inflationary increases, before that the tax stepped up sharply for a number of years leaving many businesses in the sector struggling or facing insolvency. The rapid increase in the Landfill Tax has seen businesses look to divert away from landfill as much as possible to other outlets.

One alternative has been the development of waste to energy technology designed to use elements of waste to generate heat, gas and power at a lower cost per tonne than the cost of landfill disposal. As with many developing technologies, there are inevitably start up challenges. We have seen a number of businesses suffer from cash flow difficulties as a direct result of technological ambition outstripping capability and funding.

In the UK, the current supply of waste is larger than demand so around one million tonnes of waste a year gets sent overseas to be used in waste starved power stations. That it is cheaper to do this than deal with the waste domestically cannot be commercially viable over the long term. Notwithstanding vulnerability from foreign exchange rates and the regulatory uncertainty of Brexit, the future of exporting waste oversees could be very challenging in the longer term.

Many waste transfer stations operate mechanical and biological sorting procedures to extract valuable materials. Another output which has been hit hard by falling commodity prices is metal and other recyclables. Extraction rates are consistent, so the lower selling price directly impacts on the bottom line of the business.

Further, because of the combustible nature of waste, waste operations have historically represented a greater fire risk than many other businesses and so insurance premiums and excesses are high, if indeed available at all. From a funder’s perspective, the value of any security must take into account any liquidated damages counterclaims against the debtor ledger; clean-up costs of any property before it can be sold; and the potential that the business is closed down rather than being sold as a going concern.

It should also be noted that the Environment Agency is a major stakeholder in any waste operation and has the power to suspend or terminate trading and prosecute individuals. Remedial works and CAPEX can again tear into wafer thin operating margins. As such, whilst waste and recycling operations can appear a solid funding proposition, before you get your hands dirty, think hard about the risks.

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