Small Caps | Jun 19 2014
-Forecasts too bullish in the first place?
-Brokers wary of margin compression
-Longer term outlook more robust
By Eva Brocklehurst
A profit warning from integrated waste manager, Tox Free Solutions ((TOX)), has provoked disappointment among brokers. Management expects the second half to be weaker than the first. The company is waiting for the transfer station at the Gorgon project on Barrow Island to be completed. The contract with Chevron was meant to be updated to cover operations, from a construction-based contract, back in February 2014.
Brokers are reasonably happy with the longer term outlook but have erred on the side of caution for the near to medium term. Hold ratings abound – there are three on the FNArena database, with one Buy. The consensus target is $3.41, suggesting 6.5% upside to the last share price.
JP Morgan is wary of the direction of future margins, given more focused and stronger competitors and the movement to production projects from construction over the coming years. Tox Free's revenue is 15% related to construction phase projects and this should produce margin compression as these projects move to the production phase. The broker is disappointed in that the second half should have realised increased synergies from the Wanless acquisition. Also, there was no cyclone activity, which affected first half earnings by $1m.
The broker notes, historically, the market liked the acquisitions of DMX in 2011 and Wanless in 2013, and re-rated the share price accordingly, given the accretive nature of these acquisitions. The last three years have disappointed in that regard, with reported results 10-15% below expectations. JP Morgan thinks consensus forecasts have been far too bullish on future prospects. Another aspect of the update concerning the broker is the absence of commentary regarding tender activity. At the first half result the company had indicated tender activity was at an all-time high.
Morgans (as opposed to JP Morgan) would like to see contract success in the infrastructure area before factoring in a stable outlook and looks for price weakness in order to become a buyer. The broker believes, longer term, the company will diversify and offer stronger prospects. Morgans is also concerned about further margin pressure in the near term, retaining a Hold recommendation. Margins in the infrastructure segment are generally lower than those which companies traditionally receive in resources and oil & gas. Hence, Tox Free will need to win nearly twice as much infrastructure work to deliver the same margin contribution.
CIMB does not find compelling value in the stock and thinks subdued conditions on the east coast create a higher degree of uncertainty around FY15. Government infrastructure spending will not help the business until 2015. CIMB reduces FY14 and FY15 earnings forecasts by 7% and 4% respectively. The broker observes the pipeline of projects is strong but the awarding of these contracts is taking longer than usual.
Macquarie downgrades FY14 earnings forecasts by 7.7% and acknowledges the industrial and waste services business are subdued for the infrastructure and commercial sectors. The broker retains an Outperform rating as the medium term outlook is more solid, supported by CSG drilling in the Surat Basin, which is not expected to peak until 2020. Macquarie believes the softness is short term and expects the east coast waste market to pick up into FY15, as the housing sector grows and some infrastructure projects commence. The company is also expected to finally move into the operational phase at Gorgon during FY15.
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