huntleys report, page-3

Huntley's Recommendation: Transpacific Industries Group Limited

Recommendation: Buy

TPI provides waste management, recycling and industrial cleaning services - all largely essential services - and also distributes premium-end, heavy duty commercial vehicles. Listed in May 2005 it has a relatively short public company track record. In that time it has grown rapidly via acquisition, making good use of highly priced scrip. In the Waste Management and Recycling division and Industrial Services division TPIs rapidly increasing scale in both the range of services it offers and geographical coverage is establishing an increasingly powerful market position. Its shares of the various waste management markets in which it operates allow for at least a doubling before incurring ACCC concerns. The founders retain a significant stake. In the current climate of rising debt costs, the high level of financial gearing has concerned some investors. This fear is arguably overdone given dependable cash flows. The stock is suitable for growth investors with a higher risk profile.

Event12-Jun-2008
The sharemarket continues to trash TPI, due to its relatively high level of gearing now compounded by the perceived impact of higher fuel prices. EBIT covered interest only 2.3 times in 1H08. There are also lingering concerns regarding the pace of acquisitions and potential attendant complications, although the track-record is so far without blemish. In response to continued queries about its debt profile the company released further details to add even more transparency.

Business Impact: The company remains the leader in a defensive industry. We do not anticipate any need to raise equity to pay down debt. The company has already assembled an impressive set of assets that should generate sound organic growth for several years, making additional acquisitions less crucial. The company said ¡®it is intended and assumed that all future acquisitions will be settled with TPI shares.¡¯ Any need to raise equity would also be an invitation to hedge funds to short the stock. A falling share price doesn¡¯t make equity raisings easy, to say the least.

Forecast Impact: --

Recommendation Impact: Due to more equity raised at lower prices in the future funding mix, we increase the future equity base by 6%. Combined with a marginal increase in costs due to higher fuel prices we lower Accumulate and Buy trigger price levels by 8% to $9.20 and $8.45 respectively. We have restated earnings to be after the impact of preference share dividends. The stock remains a Buy.

Event Analysis
The sharemarket continues to trash TPI, due to its relatively high level of gearing now compounded by the perceived impact of higher fuel prices. EBIT covered interest only 2.3 times in 1H08. There are also lingering concerns regarding the pace of acquisitions and potential attendant complications, although the track-record is so far without blemish. In response to continued queries about its debt profile the company released further details to add even more transparency. TPI forecasts a total of $2.2bn of net debt at December 31, 2008. Around $1.1bn of debt is fixed at 7.8% for two and a half years, another $325m is variable at 8.7% with two and a half years to term, and $350m attracting 8.5% and maturing at December 31, 2008. Management expects the latter to reduce to around $250m by the end of the year when it is due. A 6.75%, $296m convertible bond has 7 years to run and is to be settled by equity. The weighted average cost of debt is 8%, no different from our existing expectations. Management said their free cash flow projections suggest the company could extinguish all debt within 8 years. But future rates could be higher than management¡¯s assumptions which they did not disclose. The release also said that further funds will be available to apply to debt as TPI continues to develop and realise value from its significant landbank. The company remains the leader in a defensive industry. We do not anticipate any need to raise equity to pay down debt. Due to more equity raised at lower prices in the future funding mix, we increase the future equity base by 6%. Combined with a marginal increase in costs due to higher fuel prices we lower Accumulate and Buy trigger price levels by 8% to $9.20 and $8.45 respectively. The stock remains a Buy. The increasing cost of debt significantly derails TPI¡¯s acquisition led expansion strategy. It is now more expensive and less palatable to shareholders to employ debt to fund purchases particularly if the balance sheet is already a little strained, meaning TPI will need to use significantly more equity. A note to the schedule of debt states ¡®it is intended and assumed that all future acquisitions will be settled with TPI shares.¡¯ With a lower share price this source of funding becomes more expensive, much more dilutive for existing shareholders. Acquisitions may have to go on hold until delivery of impressive earnings rekindles confidence and the share price. We doubt much of an improvement in the current risk averse climate. Deferring acquisitions could lose targets to another buyer, or at best delay the earnings benefits. The company has already assembled an impressive set of assets that should generate sound organic growth for several years, making additional acquisitions less crucial. Any need to raise equity would also be an invitation to hedge funds to short the stock. A falling share price doesn¡¯t make equity raisings easy, to say the least. While fuel will inevitably have an impact, TPI enjoys strong pricing power evidenced by frequent price increases that have exceeded CPI. We would expect the majority of fuel price increases to be passed on to customers. This though may have an impact on demand. The company enjoys a partial hedge via its investment in fuel recycling plants that are being established around the country. The Commercial Vehicles division is also likely to suffer. The division contributes a relatively small proportion of group EBITDA, around 10%.