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73.0¢ transpacific industries group ltd

revisiting investment thesis, page-77

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Gralynchett

369 Posts.

03/10/14

21:23

Post #: 14073941
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Originally posted by madamswer ↑

Hi Deja,

Long time, no speak.

For a story that went largely to script, notably in the form of a completely de-leveraged balance sheet, the stock price initially responded largely the way I had hoped/expected, as the financial risk was all-but-eliminated.

If my memory serves, I remember the debate on Hotcopper when the share price was around 77c or 78c, in which I had envisaged 4 separate scenarios, with expected target prices of, respectively, around 90c, 97c, 120c and 155c.

I recall at the time probability weighting those scenarios by likelihoods of 20%, 30%, 40% and 10%, respectively, leading to a resultant weighted average target price of 110c

The stock price dutifully got there as the re-rating started to take shape following the full repair of the balance sheet in early 2014. At 110c share price the EV/EBITDA multiple was around 7x, which I thought at the time was an appropriate rating for the stock, and a level at which I would ordinarily have been happy to continue owning the business on assumption that the surplus cash flow would be returned to shareholders (in all likelihood, a share buyback would have been the preferred capital return mechanism, given the limited level of franking credits).

Trouble is, on the full-year result teleconference, it became clear to me that shareholders would not be getting their greedy paws on the surplus capital; rather, the CEO had been mandated to grow the business by acquisition.

On this conclusion, I sold the bulk of my TPI stock on the same day.

You see, I thought the New Zealand business that was sold had its own challenges (it was facing all sorts of anti-competition questions by regulators and besides, and it looked to have been operating at the top of its earnings cycle), so I had no issue with them selling it, especially at the attractive price they were bid for it.

But what I did not expect/want as a shareholder was for that capital to be re-cycled into acquisitions in Australia. I think it is difficult to acquire astutely in this industry because of the always-lofty vendor expectations, as well as the competitive business environment, generally.

It was an acquisition spree in the mid-2000s that got this company into a pickle in the first place through the destruction of shareholder value by paying excessive prices for businesses.

Of course, the new piece of information that emerged from the result was the need for an extra ~$30m pa for 5 years for landfill rectification and remediation spending, which I suspect might have surprised some holders of the stock.

Since the result we’ve also had the small matter of the brief grounding of the fleet, which I think is what has further soured sentiment towards the stock.

I have to concede that, given these updated developments, the likelihood of Scenario 4 coming to pass is negligible, absent a takeover offer for the company.

So I now think a weighted average target price of 100c is more realistic (derived, somewhat scientifically by 30%, 50% and 20% weightings of Scenarios 1 to 3, respectively).

In effect the de-leveraging has occurred, as expected, but the desired subsequent re-rating hasn’t, leaving the stock still-languishing at a lowly 5.0x EV/EBITDA multiple.

And it is difficult to see what catalyst gets the stock back to what I would consider an appropriate rating of 7.0x EV/EBITDA.
(But then again, having a business owner mindset, as opposed to that of a short-term stock “renter”, one thing I’ve been inordinately poor at, is the identification of “catalysts” for share prices)

In closing, while I didn’t do quite as well out of TPI as I thought I might at the outset (I returned about 40% over a period panning some 36 months – crudely around 12% pa - which is satisfactory, but not mouth-watering), I am happy that my approach to buying the stock proved the limited downside risk, because as the years go by, I am increasingly of the view that the most important aspect to investing is far less about jagging the multi-bagger, but it is about avoiding permanent capital losses.

I console myself with the thoughts that in any portfolio of stocks, there will be one or two that fail to deliver the quantum of financial returns envisaged.

And hey, if all my mistakes result in a 12%pa positive return, then I will always be delirious about that sort of outcome!

Best

Adam

PS. If you held a gun to my head and asked me what I thought the share price is going to do from here, then I would hazard that it will gradually migrate upwards as a new set of “growth” investors, who are partial to acquisitions, migrate to the stock. But I will be a seller of my remaining small holding if the share price gets close to 100c again.

Expand

It would seem that I started buying at almost exactly the same time Madamswer was selling which is slightly concerning. I bought my initial position after reading the FY14 results, and have been adding to that position with the recent share price weakness.

From my perspective, this has always been a two part story:

The deleveraging story

The efficiency & growth story

The deleveraging story has now played out, and kudos to management for getting that under control. With new management in place and renewed balance sheet flexibility, TPI is in a great position to now start focussing on the second part of the story.

Prima Facie the FY14 results were poor, however the headline number belies the cash generating ability of the company. The prior two financial years have delivered cumulative operating cashflows of $506m and free cashflow (excluding the sale of businesses) of $198m against a current market capitalisation of $1.3bn. A pretty decent result, but taking into consideration debt levels, unwinding of legacy issues from the debt fuelled acquisition spree and general economic conditions the result is more impressive.

The key objective of management, I believe, should now be to improve operational efficiency and return the remaining businesses back to growth. The FY13&14 results of the Cleanaway division and especially the Industrial division have been underwhelming, with both experiencing declining revenues, profits and margins over the past 3 years.

My interpretation of management's strategy to improve TPI's overall performance be classified into two broad categories:
1 – Operational efficiencies
2 – Industry consolidation/acquisitions

Operational Efficiencies:
With the balance sheet now in tip-top shape, I now expect Bobby Boucher to shift his focus towards implementation of best practice across all businesses, improving fleet and labour utilisation and reduction of back office costs (at least that's what he said he'll do in the CEO's report). Bob's bio suggests he is somewhat of an expert in this area having managed something similar at previous employer Synagro. I'm going to give him the benefit of the doubt and assume he'll achieve those objectives to some extent, which should improve profitability in term of both $'s and margin. However, I think the real growth catalyst for this business is more to do with point 2.

Industry Consolidation/Acquisitions
As a generalisation, I'm not a strong advocate of growing companies by way of acquisition. All too often there is very little reason to acquire a business other than to increase profits. That would be ok, if it didn't also come with with high levels of valuation/execution/integration risks.

I see TPI as being a different situation in that not only would the right acquisitions be earnings accretive, but they would also serve to make it a better business. More than many businesses, TPI will benefit greatly from the effect of economies of scale and operational leverage. Boucher was at pains to point out that acquisitions will be in the form of landfill assets (which ensure capacity for growth and scalability) and “small... tuck-in” acquisitions ie: don't expect them to be out there making a bid for their direct competitors. The waste management industry is still a largely fragmented industry and I believe the bigger players would benefit from some consolidation within the industry. For evidence of that I look to the U.S where the industry is less fragmented than Australia and similar companies (eg: Waste Management, Republic) trade on more expensive multiples.

Given TPI's history I will be keeping a very close eye on any acquisitions and level of gearing. The intangible asset balance is a constant reminder to me of the previous management's spending spree. However, given it's a new management team I'm mindful not to tar them with the same brush.

If I assume a p/e of 15 is reasonable for a business such as TPI (conservative I think), a $50m EBIT increase to adjusted FY14 earnings would equate to a share price of ~93c*, while a $100m increase would be ~$1.26* or a >50% increase from current levels (*excludes the effect of minority interest and carry forward tax losses). Those numbers may seem large against current underlying EBIT, but through a combination of efficiency gains, acquisitions and internalisation of landfill assets I think they're very achievable. I think earnings downside risk is low given the growth strategy, and as mentioned previously the risk is really around bad acquisitions and re-leveraging.

I can't say with any degree of certainty when we'll see a meaningful change in earnings, but in my investment case I've assumed it's an FY17 story.

Regards
Gralynchett
TPI Price at posting: 80.5¢ Sentiment: Buy Disclosure: Held
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