revisiting investment thesis, page-78

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
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