revisiting investment thesis

I have received some correspondence enquiring about an update of thinking about TPI given the strong share price performance in 2013, and also,in the context of the company's full-year result.


For starters, putting the full-year result into context:

I think the company delivered a credible FY13 result under what was clearly the perfect storm from a business environment.

Almost everything that could go wrong in the past 6 months, did:

- Australian manufacturing sector slumped
- Businesses generated less wast
- And the quality of waste, itself, was poor, especially liquids
- The exchange rate worked against the company
- Commodity prices (cardboard, tallow, fuel oils) fell – this alone had a $10m adverse EBIT impact
- Project deferrals were seen everywhere


But, to be perfectly honest, while I took a brief look at this result, I haven’t performed any close analysis of it.

The reason being that I don’t think this particular result is that meaningful or critical in the context of the overall value creation equation.

What do I mean by that?

Well, I continue to look at the company’s $1.5bn operating cost base and every time I read pronouncements by the company’s new management it reinforces to me how dysfunctional the business still is on so many levels (financial systems, industrial relations practices, business performance monitoring, asset utilisation, optimisation of capital allocation).

I therefore believe firmly that the major valuation uplift will come from the ripping out of a further $100m or more out of the cost base of the company, through simplification and streamlining of the business, the elimination of inefficiencies, and improved asset utilisation.

I don't think it can be overstated just how inefficient a shape the former management team of this company left it, and therefore how much upside exists under a more commercially focused, and shareholder value astute, management team.

So, to me, TPI presents a story of multi-year, cost outworking potential.

There is significant value that can still be liberated.

Trouble is, with the CEO chair vacant, the process is delayed, and is unlikely to get into full gear until the new CEO gets his feet under the table, gets to grips with the issues and signs off on the way forward.

One always has to be realistic when it comes to investing, I believe, and the streamlining and simplification of the business will only be a 2015 story, at the earliest.

But in the meantime, the low hanging cost reduction fruit will continue to be found and harvested and the bottom-line will continue to grow via de-leveraging.

Most importantly, the balance sheet now in much-improved shape since the successful divestment - for a price that handsomely exceeded analyst valuations - of the Commercial Vehicles business (NIBD/EBITDA is now 1.9x, its lowest level since the mid-2000s before the former management team undertook a manic acquisition spree that ended in tears).

With the 50% appreciation of the share price in 2013, despite a series of downgrades caused by the very poor business environment, the re-rating process has clearly begun and I fully expect it will continue, from the current EV/EBITDA of some 5.5x, and I think it will reach industry norms of 7.0x to 7.5x within 18 months.

That valuation multiple re-rerating process, combined with what I like to call "re-equitisation" (i.e., when natural de-gearing causes the EQUITY value to replace DEBT in the numerator of the EV/EBITDA multiple) will result in ongoing share price appreciation, I believe.

But given the good performance of the stock in the past 12 months or so, a lot of the short-term Alpha has been banked, I suspect. So I don’t see the stock doing anything dramatic on the upside from here on.

So besides what I foresee to be modest valuation uplift due to valuation multiple re-rating combined with "re-equitisation", as discussed above, I think the major valuation uplift will come from the ripping out of a further $100m out of the cost base.

TPI is not one of those share-price-doubling-every-year situations; instead I see it delivering acceptable returns of 12% pa to 15% pa, with limited downside as the broader market comes to view the stock as now being significantly de-risked from a financial point if view, and also from the bottoming of the business cycle.

I see TPI as a low-risk, modest-return investment on a 3-year time horizon.

No fireworks, but sleep-easy-at-night....the way I like to invest..