Thumbs Up For Tox Free Acquisition

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-Exposure to top companies
-New end markets for product
-Synergies available

By Eva Brocklehurst

The market place for Tox Free Solutions ((TOX)) is expanding. For $70m the company has acquired Worth, a recycler based in NSW. This liquid waste and industrial services business is expected to generate $12.9m in earnings in FY16. Macquarie considers the acquisition a good fit, as it diversifies Tox Free's business both in terms of geography and customers, and the price is also reasonable.

Trading conditions are expected to be challenging in the second half, especially as Gorgon volume declines, but the broker expects this will be countered by increases in LNG volume as the new Western Australian plants commence production. The tender pipeline is strong and Tox Free is expected to grow market share over the medium term.

The company can more than offset the decline in business at Gorgon, as it transitions to production, with the delivery of the majority of the $80m per annum in tendered contracts that it held at the first half, in Morgan Stanley's belief.

The Paint Manufacturers Federation stewardship scheme and the Karratha incinerator will proceed in FY17. The broker's base case assumes that recycling volume within the Australian economy grows at a compound 4.0% for the next five years, moderating towards 3.5% after that.

The strategic and financial rationale pleases Morgan Stanley too. Financially, the broker estimates the acquisition to be 12-13% accretive to FY16-17. It also moves the business footprint to a more national basis and away from oil & gas exposures.

Moreover, it complements the Wanless and Dolomatrix assets and provides a means to increase Tox Free's services through bulk liquid waste treatment and soil remediation capabilities. It also aligns Tox Free with the faster growing east coast market and should provide an opportunity to introduce the company's E-waste BluBox technology into NSW. The broker observes gearing is at the top end of management's guided range but is more than manageable.

Worth's top tier customers include Caltex ((CTX)), BlueScope ((BSL)), Thales, IOR and Ventia. UBS observes NSW could represent 16% of group revenue post acquisition. The broker raises FY17 earnings estimates by 11.%% and FY18 by 10.4%.

The acquisition is consistent with the company's stated strategy of acquiring assets with highly technical capability, UBS asserts, and diversifies the exposure to an end market whose economics are driven by different factors compared to the company's bases in Queensland and Western Australia. UBS remains cautious in that Worth has a degree of exposure to the resources sector which limits the diversification benefits.

The transaction should be positive for investors, Ord Minnett believes, as it is a strategic move in a market where there is considerable nervousness about the near-term prospects for many companies. The broker flags Worth as a leading business, with EPA-licensed facilities in south Windsor and St Marys plus operations in the Illawarra and Hunter Valley.

While suspecting the mix of acquired assets is likely to be of higher value than Tox Free's current business mix, Ord Minnett suggests much of the earnings accretion from the transaction is driven by the funding structure – 70% debt funded versus 27% gearing for the group.

Furthering this argument, the broker maintains that earnings and value accretion are often mistakenly interchanged. Ord Minnett accepts the transaction will probably be value accretive to Tox Free shareholders, given diversification benefits and synergies from rationalisation of sites and plant.

FNArena's database contains three Buy ratings and two Hold. The consensus target is $3.03, suggesting 10.3% upside to the last share price. This compares with $2.86 ahead of the announcement. Targets range from $2.45 (Morgans, yet to update on the acquisition) to $3.45 (Macquarie).
 

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