Where do I start with this company? The main thing that held back Coote industrial was the Greentrains debacle. The amount of debt that sat on Coote industrial's balance sheet was detrimental to their business. However, one good thing about Coote is their action plan to tackle the debt behemoth is finally in swing, with the first tranche of Greentrains's settlement reducing gearing (interest bearing Debt/ Equity) to 85%. [Note: The Equity mentioned here is not the market cap. of the company but rather Equity on Coote's balance sheet]
These are my thoughts on Coote industrial:
1) Their current debt level sits at approx. $114million, which is 85% of their balance sheet Equity. Of this $114 million, they expect to reduce it by another $50 - $60 million within the next 3 months as they progress their sale of South Spur + second tranche of Greentrains selldown.
2) Of the $50 - $60 million in debt reduction, $35 million is to come from Greentrain's 2nd tranche. Therefore, the expected sale price for South Spur is approx. around $20 million.
3) The first step for CXG's re-rating will occur when South Spur is sold + the sale of Greentrain's 2nd tranche. Once this step is done, I expect CXG's share price to re-rate towards the $0.50 mark. When this step happens, interest bearing debt will drop to approx. $65 million. This represents a massive debt reduction of $84 million (from $149 million in FY'09 to $65 million).
4) The debt reduction strategy in place is workable and reasonable. Furthermore, it does not dilute existing shareholders significantly (i.e. no massive placements or 5 for 1 rights issues etc.) The placement to Elphinstone is necessary as it provides some credibility to gather other investors into Greentrains. Whilst Elphinstone will end up with 25% of Coote industrial through his convertible note placements, I am more than happy for him to be a corner stone investor in CXG. He will bring some mettle to the company.
5) There needs to be some management changes. There needs to be greater emphasis placed on recruiting highly skilled management personnel as well as non-executive directors. Mike Coote has done really well in progressing the company to where it is now, however, we will need to re-jig some of the team to provide much needed change.
6) Even with the dilutionary impact of Elph's cornerstone stake, the number of shares will rise to only 146.4 mil. The trick with CXG is to make sure they can keep their costs down. Even if you factor in a drop of 20% in revenues (from $317mil to $250mil), CXG can easily earn an NPAT of $11.25mil in FY'10. I only used a NPAT margin of 4.5% in my calculation, which is conservative. So, based on the diluted share base and using a P/E multiple of 9x FY'10, the target price arrives at approx $0.70/share.
7) The bulk of Coote's FY'10 turnaround will occur in the 2H. So, do not be perplexed if you do not see a marked turnaround of CXG's fortunes during the Feb'10 reporting season. The turnaround will gain traction when the sale of South Spur and 2nd tranche of Greentrains goes through. Additionally, there may still be some short term impact in 1H'10 due to further redundancies.
8) Currency, currency, currency. A high AUD$ can only bode well for the fortunes of CXG as they are importers of parts. It should be noted the AUD$ was in the doldrums for the best part of Nov'08 to early May'09. The AUD$/USD$ above 0.80 can only be great for CXG. Don't ever underestimate the currency impact for CXG.
9) Costs will be permanently down in FY'10 as CXG has undergone a staff reduction programme + a huge reduction in their interest bill (especially in 2H'10).
All in all, I believe CXG is a turnaround story for investors who are patient. Near term catalysts will be further reduction of debt. This is one of the few companies who is able to do a 180 degree U-turn on their business fortunes if they execute their debt reduction stratgey correctly. Not for the short term trader. This is a patient investor's stock.
Happy investing
NOTE: [These above mentioned calcualtions are conservative in nature as the profit margins in the past have been much greater than 4.5%. Additionally, there will be more upside if CXG is able to keep their revenue stream fairly stable]
CXG Price at posting:
28.7¢ Sentiment: LT Buy Disclosure: Held
