Having completed its turnaround, Tox is now in substantial...

Having completed its turnaround, Tox is now in substantial growth phase. In the
six months to June 05 profits were double initial expectations, and we believe the
company is very likely to overshoot 05/6 forecasts too. As a result, we have
upgraded our current year forecast from $2.8m to $3.5m.
We would not preclude further upgrades as the year progresses. Significantly,
we now believe our 06 and 07 forecasts can be achieved without the benefit of
plant upgrades. A potential $1.5m retort upgrade at the thermal desorption unit
at Kwinana would therefore lead to a further step change in forecasts.
Tox has a niche position in the hazardous waste market. Margins are attractive
and the barriers to entry are high, both in terms of regulation and know-how.
Indeed Tox’s own history shows that the learning curve can be steep. Tox now
has numerous opportunities for growth, including complementary technologies.
Despite its recent run, this fast growing business, which is now ready to appeal to
institutional investors, is arguably still undervalued.
Background
Tox Free Solutions (“Tox”) treats industrial and hazardous waste through a variety
of technologies. Its Kwinana plant in Perth’s heavy industrial area houses a
thermal desorption unit, which treats contaminated soil, primarily on behalf of
land developers. In addition, Kwinana has also secured a major contract to treat
packaged waste and has a growing liquid waste operation. The other major unit
at Port Hedland is ideally placed to serve the resources industry in the Pilbara
region. It treats industrial waste by thermal destruction ie through a kiln, and also
processes liquid waste. In addition, the group owns a mobile automated tank
cleaning unit in the Pilbara region which we expect to be sold shortly
Having floated at 50cents in September 2000, the old Tox was beset by technical
problems, notably with the thermal desorption unit at Kwinana. In the year to
June 03, the group made a loss of $3.8m, a situation which clearly could not
persist. New management was brought in, headed at the non executive end by
Ian Burton and operationally by Steve Gostlow. Their initial focus was restoring
the group to profit. This involved a reduction in central overhead of $1.5m p.a,
but perhaps more significantly the elimination of lossmaking or lower margin
business at both plants. The success of this strategy quickly became apparent.
Although sales to June 2004 were almost $2m lower at $4.1m, a gross profit of
$1m was achieved and operating losses were reduced by almost $3m to $900k.
Both plants have the potential for enhanced performance if technical upgrades
are implemented, especially at the thermal desorption unit at Kwinana.
However, 2005 has seen a much quicker and stronger return to profitability than
expected, as a result of a number of factors, such as improved mix, unit
efficiencies, remarketing of the group’s services to a generally buoyant customer
base, and new activities. In our original coverage note dated 24th February 05,
we expected Tox to make a $700k profit in the second half ( Jan to June 05 ), but
in the event the group announced in July an unaudited profit of $1.45m.
Significantly, second half sales of $4.4m were double the first half and higher
than 2004 as a whole.
Return to profit, and growth 03a 04a 1H 2H 05a
Sales 6.0 4.1 2.2 4.4 6.6
Profit -3.4 -0.9 -0.4 1.4 1.0
Profit Outlook
On 24th August the company issued a trading update in which it forecast a base
case EBITDA for 2005/6 of $3m on sales of $8m. This is below the running rate for
the second half of 04/5, and there are several other grounds for believing this
forecast may be conservative:
- regular flow of high margin ad hoc work eg where a spillage somewhere
in the Pilbara ends up being treated at Port Hedland;
- new revenue streams eg liquid/packaged waste, document destruction,
at Kwinana following site improvements and new kit purchase. The group
is also experiencing demand for its services on a consultancy basis;
- continued efficiency improvements at both plants ( new Industrial
Chemist for the group );
- buoyant market and increased awareness of Tox’s services eg exhibiting
at a recent conference in Fremantle;
- with a largely fixed cost base, high operational gearing if sales and mix
exceed expectations; and
- longer term, with a healthy balance sheet, acquisition opportunities. Note
that Tox also owns surplus land at Karratha which could serve as the base
for a new revenue stream.
As a result, we have upgraded our own 05/6 profit after tax forecast from $2.8m
to $3.5m, based on sales of $8.8m. We are not without hope that this forecast
could be exceeded too if current trends are maintained. Note that neither this
nor our 06/7 net profit forecast of $5m include the benefit of a possible upgrade
to the thermal desorption unit at Kwinana, where the opportunity still remains to
increase production 5 times following a $1.25-1.5m retort upgrade. Potentially the
impact on profit could be very significant, and figures of $5-10m additional gross
profit have been mooted. An engineering study has been commissioned, and
we believe it is still more likely than not that some benefit will flow into 06/7 results.
Commercially, it should be easier for the unit to secure these higher volumes now
the plant is working reliably at lower levels.
Balance sheet/Cashflow
With a largely fixed cost base, the group is now highly cash generative at current
levels of activity. This year $750,000 capital expenditure has been budgeted, of
which $500,000 is growth rather than maintenance spend. Tox currently has cash
in the bank of some $2m, and with the share price now double the option
exercise price of 3 cents, we anticipate the full conversion of 100m options by
January 06, providing the company with a further $3m cash injection. This would
facilitate the upgrade at Kwinana if appropriate, and provide a war chest for
suitable bolt on acquisitions.
TOX FREE RESOURCES 2003a 2004a 2005a 2006e 2007e
Year to 30th June
Profit & Loss Account
Revenue
Kwinana 2950 1237 2000 3300 5000
Port Hedland 2057 2917 4600 5500 6000
Automated Tank Cleaning 994 0 100 0 0
Revenue 6009 4148 6702 8800 11000
Cost of sales -5932 -3045 -3550 -4000 -4500
Gross Profit 75 1003 3152 4800 6500
Gross profit margin 1.20% 26.60% 53% 54% 59%
Expenses -3495 -1918 -1791 -1300 -1500
Operating Profit/loss -3420 -915 1361 3500 5000
Interest -334 -405 -300 0 0
Profit/Loss before Tax -3754 -1320 1061 3500 5000
Taxation -31 0 0 0 0
Goodwill write off 0 -900 -1287 0 0
Net Profit/Loss -3785 -2220 -226 3500 5000
Headline diluted earnings per share -2.29 -1.23 -0.05 0.77 1.00
Underlying diluted earnings per
share -2.29 -0.7 0.27 0.77 1.00
Dividend per share 0 0 0 0 0
Diluted number of shares 165,178 180,083 360,000 450,000 500,000
Balance sheet/cashflow
Shareholders funds 6296 4251 6081 12500 17500
Net cash/debt -3122 -2051 -500 4000 6000
Gearing % 49.60% 48.20% 8.2% n/a n/a
Interest cover n/a n/a 4.5 n/a n/a
Capital employed 9418 6302 6500 8500 11500
Return on capital employed % n/a n/a 22.9% 32.00% 43.00%
EBITDA -1169 1025 2283 4500 6000
Investment Summary
There will always be risks associated with any small company, especially in a
technically demanding area such as processing hazardous waste. Accidents
can never be ruled out, which would create both business interruption and
litigation risk. However, the major problem which inhibited Tox in its early years,
namely the know how to run its units effectively, does seem to have passed.
Indeed it is this technical know how which gives the group its biggest
opportunities now, both in existing and complementary technologies, and at the
same time creates the highest barriers to entry for competitors.
Regulation also works in Tox’s favour. New competitors have to face a stringent
environmental licensing regime to get a plant up and running, whereas Tox is
already fully accredited. In a risk averse and litigious corporate world, customers
increasingly choose to outsource to Tox, who will provide a certificate of
destruction, as opposed to the cheaper alternative of land fill, where risk,
however, minimal, still resides with the customer.
As a result, and given the growth rates that Tox is achieving and the
opportunities open to it in a fragmented industry, we believe the shares should
be capable of commanding a double digit P/E rating, more than supporting the
share price at current levels.
These earnings are untaxed ( there are some $7m of tax losses at group level ),
but there are a further $17m of tax losses in the Eli Eco Logic business at Kwinana,
which, if accessible, would ensure that Tox paid a reduced tax charge for the
foreseeable future.