I’ve been watching CLG for some time but only began investing...

I’ve been watching CLG for some time but only began investing heavily after the FY results given the (in my view) unjustified heavy fall in the share price. This reflects my views on the following:

- Amortisation of customer contracts: This is a non-cash accounting construct, and more importantly, a tax deductible one. If the value of these contracts was instead included in goodwill, it would not be expensed in the P&L (unless there was an impairment), but taxes would be higher. So I’m more than happy that they are expensed, but I focus more on EBITA and PATA to assess business performance, which both showed strong growth in line with guidance;

- Debt: Debt was higher than expected due to investment in working capital. Those who had seen/read their commentary and presentations on the extension of the HP contract would note that they are taking more inventory risk (but higher volumes) on the new 3-year contract. Accordingly, this will require working capital investment as it grows. That said, this is a function of growth which is a good problem to have (as long as they can fund it which they can) and this working capital position will stabilise or unwind if the company stops growing or sales decline. Debt to EBITDA is also low at about 1x (and the company has minimal leases) so financial leverage is not a material concern.

- Debt interest costs were high but are a function of high-cost acquisition financing which will soon be refinanced on more favourable terms.

- Non-recurring costs: CLG appear to have done some restructuring of the Australian and US businesses during 2024 but didn’t break out these costs as ‘one offs’. So while some have questioned the accounting disclosures/approach for CLG, I view their accounting as prudent and conservative.

- Cashflow generation (pre working capital but after capex) was about $20m-$25m for 2024, which gives a very attractive cashflow yield of close to 20%;

- The HP contract concentration is CLG’s most significant risk, but they are building out their collection network across Europe for different customers, and will no doubt expand their customer base in the US. In my view the size and efficiency of their collection network will be a key driver of success (and barrier to competition) for early movers like CLG. The US business already has 100,000 collection points;

- This business has huge industry tailwinds. Hardware companies are under huge pressure to recycle, but it is not their main game. Accordingly, they will want to subcontract this work out to players like CLG. As long as CLG remains an efficient and high-quality provider of these services, there is no reason that customers like HP will not continue to use them. There will always be natural pricing tension at each contract renegotiation to prevent outsized returns, but as long as they are efficient with economies of scale (which will only grow as its expands its customer and geographic reach), there is no reason CLG can’t continue to generate good returns on capital and high growth. The company itself has publicly stated that it is positioned to grow revenues by ‘several times in the next 3 to 5 years’;

- All key valuation metrics are cheap. EV/EBITDA is about 4x and P/E (before customer contract amortisation) is about 5x. This is incredibly cheap for a business with this kind of growth potential;

- Substantial shareholders haven’t been selling, so it appears this is only retail investor nerves/reaction to some of the headline numbers;

- The only downside of the recent share price falls is that it limits their potential for further large acquisitions but hopefully this will only be temporary.

While many on HC appear concerned about the downside, I’m more focused on the potential for CLG to be multiples of the current share price within the next few years. Nothing is certain in investing, and the upside relies on effective management and good execution, but I like the balance of risk/return on CLG.