Waste companies win few votes in the sharemarket glamour stakes. It’s difficult, dirty, work with seemingly low margins in a commoditised industry. But some waste companies have shown how to turn trash into serious cash, and others are in value territory after price falls.
Tox Free Solutions is an example. The Perth-based company provides integrated waste services, industrial cleaning, and technical and environmental services, primarily in the minerals, oil and gas, energy, utilities and government sectors.
Tox had been one of the better small-cap performers since it listed in 2000. The 10-year average annualised total shareholder return (including dividends) is 26 per cent to December 10, 2014. However, the total return is almost flat over five years and down 32 per cent over one year.
Chart One: Tox Free Solutions
Tox is suffering from lower waste volumes as the resource investment boom fades. About 36 per cent of its FY14 earnings came from the mining and oil & gas sectors, and almost half of all revenue is made in West Australia and the Northern Territory.
At the Annual General Meeting in November, Tox said trading conditions remained challenging and highly competitive, although conditions had improved across the business in September and October. The share price has fallen from a 52-week high of $3.76 to $2.31.
The easy response is avoiding Tox and other service companies with high exposure to mining and energy. It’s hard to buy mining services stock in this market, given the prospect of further commodity price falls and more volume and margin pressure for service providers.
But Tox is a different service business on several fronts. Its waste disposal is an essential service rather than discretionary spend for larger organisations. And waste volumes in the resource sector should benefit in coming years as production volumes rise.
Tox should also benefit from the Federal government spending $50 billion in infrastructure over the next seven years, and another expected $70 billion in State government and private expenditure. Tox said at the AGM: “Significant spending in the infrastructure sector has been announced and we are starting to see momentum in this area.”
Longer term, Tox says the $13 billion Australian waste market should grow at an average 5.2 per cent annually, and that it has an addressable market of $4 billion of work annually. It says the available target for blue-chip clients in production is more than $1 billion and still growing at 10 per cent annually as companies require greater waste-management services. It’s a large, fragmented industry with plenty of room for growth.
Tox’s return on equity (ROE) has been near or slightly above 10 per cent over the past five financial years -well down on average ROE above 20 per cent from FY06-08. Net gearing of 34 per cent and interest cover of 6 times in FY14 is reasonable for a company that has been highly acquisitive over the years, and better than many resource-related service companies in this market.
The bad news is weakening trading conditions as the economy transitions from the mining investment boom to stronger growth in housing and infrastructure investment. The key questions are: is Tox doing enough to offset the downturn; and has the market excessively priced in weaker trading conditions after heavy share price falls this year.
Tox says it is targeting $50 million of new total waste-management and industrial-service contracts and that it has shed 36 employees and found other efficiency gains. It has already achieved $15 million of that $50 million and is waiting on decisions for another $20 million of work. Tox expects first-half FY15 underlying earnings of $32-34 million if current trading conditions continue – a touch below the $34.8 million delivered in first-half FY14.
At $2.31 a share, Tox is on a forecast Price Earnings (PE) multiple of 11.4 times FY15 earnings on Morningstar numbers. Four analysts who cover Tox rate it a buy or strong buy, and two a hold, according to consensus analyst forecasts.
Morningstar’s valuation is $2.80 a share and it has an Accumulate recommendation. Macquarie Equities Research has a $3.12 share-price target and an Outperform recommendation, and it wrote after the AGM that the “tide is turning” for Tox.
Macquarie said: “We believe Tox Free has been oversold. We expect the east coast waste market to pick up into FY15 as the housing sector grows and some infrastructure projects commence. We also expect Tox to move onto the operational phase of the Chevron contract during FY15 and to see some results from Tox’s large tender pipeline.”
I’m not as bullish in the near term, principally because of Tox’s mining exposure and that government infrastructure projects often take much longer than expected. It’s hard to identify a significant share-price re-rating catalyst in the next few months and sentiment is clearly against Tox and other service companies that rely on mining companies for work.
Nevertheless, long-term investors should watch and wait for better value over the next few months. Tox is a good company in a good industry with plenty of long-term growth options. It just needs to get through a challenging transition from mining investment to growth in other parts of the economy, something it appears to be doing, based on recent contract wins and sector growth.
Watch for Tox to form a share-price base over the next six months and keep an eye on contract wins and the first-half FY15 result next year. Signs that it is offsetting weak trading conditions in mining, through stronger growth in other divisions, would be the catalyst to buy,
Tony Featherstone is a former managing editor of BRW and Shares magazines. Readers should do further research of their own or talk to their adviser before acting on themes in this article. This column does not imply stock recommendations. All prices and analysis at December 12, 2014.