Transpacific No Longer Rubbish


- TPI result surprises - Trend improving - Recovery story beginning - Not without risk

By Greg Peel

Once flying high with an $11 stock price, waste collector and recycler Transpacific Industries ((TPI)) found itself a significant victim of the 2007 global credit crunch as the market rushed out of over-leveraged companies and property/infrastructure funds. The GFC proper provided another slug, and a weak trading update last November sent the share price to its lows under 70c.

By contrast, Friday's first half FY13 profit result announcement sent TPI shares rushing up 13%. The bottom line here is that while the result was no means a cracker, it was a lot better than that November update had suggested.

Lower interest expense meant TPI's profit result came in well above consensus, albeit the earnings result was largely in line with broker expectations. The result represented a 4% drop from the first half FY12, but given the November update had suggested a 6% drop with a dour outlook from management, sending the share price down 25%, this slightly lower loss basically took the market by surprise.

TPI's core Waste Management division showed an 8% drop in earnings for the period, driven by a mix of carbon tax, higher landfill levies, lower landfill volumes, with subdued construction activity having an impact, and subdued trading activity. While the nearer term outlook provides no real change to current conditions, the good news is that Waste Management's performance improved in the second quarter from the first. The Commercial Vehicles division saw a 71% jump in earnings to offset the loss in Waste, and this is not likely to be repeated. The upside story is very much a Waste Management story.

WM is highly leveraged to a turnaround in Australian economy, particularly in construction. This is not going to happen overnight. In the meantime, TPI is undergoing a significant and very slow-moving restructure. Again, the benefits will not be an overnight story but having been beaten down so far, the company appears to now be on the road back, analysts suggest.

As noted, debt has since 2007 been the company's stumbling block. UBS suggests the first half result "provides clear evidence of the strategic efforts to reduce the financial leverage of the business". The reduction in interest expense is testament. At the result release management upgraded its cost savings guidance for the next three years from $30-40m to $50m which Credit Suisse sees as a "clear positive". Throw in divestments and efficiency gains and the TPI story is looking rather encouraging.

Indeed, JP Morgan notes management appears reluctant to sell off the Commercial Vehicles division, which is understandable given the 71% earnings jump and offset to weak Waste in recent periods. But with management suggesting Vehicles has now hit "mid-cycle earnings", hence no longer offering such earnings improvement, the timing is right for the business to be divested in JPM's view.

Divestments aside, JP Morgan is sticking with Neutral for now given TPI's margins are still trending down even as losses from Waste begin to ebb. The analysts would like to see a positive earnings result before becoming more confident. Credit Suisse (Neutral) is "tending towards a more positive bias" but would also like to see margins improve and believes the risk justifies the stock's current valuation.

Macquarie has always maintained TPI boasts an attractive suite of assets and that the company has the potential to realise operational improvements and significantly reduce medium-term leverage. The modest improvement in the company's second quarter is enough to draw an upgrade from the broker to Outperform.

Deutsche Bank sees a recovery story that is on track and offering upside and maintains its Buy rating, as does CIMB, who believes TPI's growth story is "just starting".

Post result, the six FNArena brokers covering TPI are split between four Buys (or equivalent) and two Holds. The consensus target price has jumped to $1.04 from 91c, suggesting a further 10% of upside despite Friday's 13% re-rating.

After five years on the rubbish tip Transpacific's long road back through significant restructure and deleveraging appears to have begun, although we're only at the Chairman Mao stage, and analysts, while becoming more confident, are quick to warn there are still risks involved. Perhaps a sleeper for those with a bit of tolerance.

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