Waste: opportunities and challenges

Guy Hands has just bought Waste Recycling Group, cash shell Augean is raising funds for acquisitions, and suddenly the sector is alive.

Existing waste players (see box) are in a good market. EU directives mean we have to find expensive alternatives to landfill and pre-treat all waste. This means a growing subsector in recovery and recycling: from £1bn now to £5bn in 2014, driving a doubling in the market as a whole.

But this market faces three important new challenges.

1. Waste directives are complicated, output-driven and written in legalese. Local authorities have responded by passing this complexity straight to contractors via integrated waste management contracts (IWMCs), which cover all stages from collection, sorting, recovery, recycling and landfill.

   These are essentially £500m PFI projects with long-term revenues allowing the contractor to invest in the necessary infrastructure, such as composters, energy from waste facilities, and recycling plants. PFI projects entail long and expensive bid processes, which means there is a sudden shortage of human and financial bidding resources. This is the first challenge.

1. The second challenge is mastering the technology. The UK’s position as one of the leading users of landfill means that our technology experience has been largely limited to diggers and dump-trucks. Recovery and recycling is now needed, and there is considerable choice in the nature and price of the technology to achieve this (see chart below).

Waste and utility companies, such as Severn Trent, will have to use their technology portfolio expertise to invest in market-leading technologies and ensure value for money. Waste-only companies without this experience may struggle.

1. Finally the PFI nature of the IWMCs means that considerable capital resources are needed to fund the construction of the waste treatment plant and to absorb negative cashflows until the project reaches maturity.

We estimate an average capex requirement of £100 to £200 per tonne treated - see chart below. Given 65 million tonnes of waste now, of which 80% will need to be treated by new build plants by 2007, this creates a capital need of £5-10 billion.

The industry currently has net assets of £2bn, so this is a herculean task.

Waste is a dynamic and growing market, but one that requires existing players to up their game. If they don’t, management from outside the industry will surely step in.

Any market forecast to double in size in the medium term is likely to be attractive. But as our analysis makes clear there are the considerable challenges of bidding, technology and finance.

Who might be best placed to meet these challenges? Some incumbents such as Severn Trent look strong. Outsiders with experience of PFI, such as Capita, may have a role to play. Private Equity will surely fund some of the capex needed.

This is a market we will watch with great interest in 2005.

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