The sharemarket has a habit of surprising in places least expected. After years of underperformance, clean-tech stocks have had little attention compared with information technology or life sciences stocks. Now they are collectively beating the market.
The Australian Clean Tech Index, a barometer of 62 ASX-listed stocks, returned 16.6 per cent in FY15, easily eclipsing the S&P/ASX 200 index’s 1.3 per cent gain.
Over six months to February 2016, the index has gained 3.4 per cent, a much better relative return than the ASX 200’s 6.3 per cent fall in that period. The index was up 2.2 per cent in February alone, continuing a strong run of outperformance.
Although these gains are impressive, always look behind indices to understand their composition and what is driving returns. By volume, the Australian Clean Tech Index mostly comprises micro-cap stocks that are too speculative for most investors. By value, big moves in its largest stocks can skew returns in the market-weighted index.
Caveats aside, investor interest in clean-tech stocks is building. Perhaps it is a by-product of broader market interest in information technology stocks, or a recognition that the clean-tech sector, after years of false starts, is closer to delivering on its promise.
There’s plenty of interest in solar, battery storage, wind power and other emerging renewables technology. I prefer waste. It’s not glamorous, but companies that move garbage are real businesses with real profits and have good prospects as the population grows.
The Australian Waste Index, a sub-component of the broader clean-tech index, returned 3.6 per cent in February. It includes stocks such as Cleanaway Waste (formerly Transpacific Industries), Sims Metal Management, Tox Free Solutions, Papyrus Australia, AnaeCo, Novarise Renewable Resources, and Intec.
By market capitalisation, the waste index, along with wave and hydroelectricity sub-sectors, would have to be the largest component of the Australian listed clean-tech sector.
Tox Free Solutions looks the pick of the waste stocks at current prices. The $349 million company is among the better-run clean-tech stocks and has been a favourite of some small-cap fund managers over the years for its growing earnings profile.
The integrated waste-management and industrial-services provider offers services in regional Australia such as the collection, recycling and disposal of various waste types. Its industrial-services business provides on-site industrial cleaning in the resource sector and it has a national network of facilities in Australia for the management of liquid and solid hazardous waste.
Shares in the Perth-based company fell from a high of $3.63 in May 2014 to $2.17 that year and, after a brief rally, fell back near those levels earlier in 2016. Like other companies exposed to the resource sector, Tox Free has plenty of headwinds. Its industrial-services and hazardous-waste divisions account for about a third of revenue.
Chart 1: Tox Free Solutions
Source: The Bull
Tox Free rallied to $2.99 this month, up strongly this week, after announcing its acquisition of Worth Recycling, a leading liquid and waste-treatment, and industrial-services business in New South Wales. It is paying $70 million for full ownership.
Worth Recycling is expected to produce underlying earnings of $12.9 million (EBITDA) before synergies from being part of the Tox Free group. Importantly, Tox Free estimates the acquisition will be 13 per cent earnings per share accretive in FY16.
Worth Recycling gives Tox Free a significant base in NSW, which is Australia’s largest and fast-growing waste-treatment and industrial-services market. It operates some of NSW’s biggest waste-treatment and soil-remediation facilities.
Tox Free believes it can leverage Worth Recycling’s intellectual property into other states, and presumably combine it with the company’s other services. It looks a neat bolt-on acquisition: a valuation multiple of 5.4 times EBITDA is in line with recent Tox Free acquisitions, it boosts earnings from day one, and does not stretch the company’s balance sheet.
Also, the deal is well timed. Although trading conditions in resource-related sectors will remain tough, demand for waste collection, at least on the East Coast, should improve in FY17 as the economy slowly lifts. Tox Free looks well placed to participate in any recovery, given its growing national footprint and improving margins as a result of greater scale.
Six of eight brokers that cover the stock have a buy and two a hold. However, a median share-price target of $2.98, based on the consensus, suggests Tox Free is fully valued.
Tox Free can do better than the market expects and several brokers still need to upgrade their forecasts after the Worth Recycling deal. One of the first to do so, Macquarie Wealth Management, has an outperform recommendation and 12-month share price target of $3.45.
I’ll stick with the bulls on Tox Free. Further gains will be slower from here and the outlook remains challenging as construction at some of the giant gas projects winds down. But Tox Free has the makings of a larger business in the next three years as demand for waste management strengthens and interest in clean-tech stocks grows.
As a small-cap stock, Tox Free suits investors comfortable with higher risk.
Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations. Readers should do further research of their own or talk to their financial adviser before acting on themes in this article. All prices and analysis at March 23, 2016.