Investor Update: Outperformers on track

Over the last two months I’ve ‘picked’ five stocks for Eureka Report subscribers, and today I want to review their recent performance and provide an update on developments.

These companies are: CTI Logistics (CLX), Energy Action (EAX), Pental (PTL), UXC Ltd (UXC) and ToxFree Solutions (TOX).

As of the time of writing, Energy Action (EAX) has reported its half-year results and the other four are due to report in the coming weeks. EAX reported results in line with guidance, and is on track for two very strong years of growth.

Of the published recommendations, Pental (PTL) has the largest share price gain with a 13% return, followed by CTI Logistics (CLX) with 5%.

In general terms, the key themes we are looking for during the reporting period are as follows:

1. How does the result compare to expectations, and will there be any change to full-year consensus earnings expectations?
2. If the result is different to expectations, is it due to one-off factors or a change in company and industry drivers?
3. Financial analysis – Looking for a healthy balance sheet, with revenue and margin growth.  
4. Cash flow – Strong conversion from reported profit to free cash flow.

Energy Action (EAX) – Short-term pain for long-term gain (1H result 18/2/14)

Energy Action reported its half-year results in line with expectations, and the company reaffirmed guidance of a flat $5 million net profit after tax (NPAT) for the full-year 2014 result. The key message from the result is that the company has absorbed the cost for FY15/FY16 growth.

While revenue grew 17%, operating profit declined 14%. The margin compression was driven by a 20% increase in its sales staff, which will enable the opportunity to capture market share during FY15/16. In this time period approximately 80% of target customers need to renew electricity contracts, compared with the traditional 25% per annum.

Previously the market would not price electricity/gas contracts past 2015 due to the uncertainty with the carbon tax. EAX’s initiative to price carbon exclusive auctions has given customers the confidence to lock in contracts past 2015.

The company has created a unique competitive advantage through 10 years of developing its intellectual property for its online reverse auctions . This allows corporate customers to select the best energy contract offer from different electricity/gas retailers. The online auction division, or Australian Energy Exchange (AEX), makes up 25% of earnings.

The amount of consumer and industrial (C&I) companies that use a broker for energy contract negotiation has increased from 20% to 50% over the past six years. In the UK, currently 80% of C&I companies use a broker for contract negotiation, and given that they are ahead of Australia in regards to when the market became deregulated, there is no reason to think that Australia won’t continue to trend towards the same percentage of brokerage usage as the UK. 

After the contract has been procured, EAX offers the customer contract management services via automated monitoring and reporting from its Activ8 platform. This division comprises 60% of earnings, and the growth outlook is healthy due to the growing trend amongst companies to outsource non-core services. The company’s third division is Sustainability – comprising 16% of earnings. While the government removal of energy efficiency funding was a hit, the division is still growing and benefiting from customers looking to cut costs through energy efficiency.

Earnings will be weighted to the second-half, with the expanded sales team now established and the contract renewal situation playing out.

The interim fully franked dividend was up 5% to 3.73 cents. With no debt and cash of $6.4 million, EAX has capacity to grow both organically and by acquisitions in a fragmented market.

With the large forecast growth and uncertainty in regards to the efficiency of the restructured sales force, we have reduced our margins forecasts resulting in a 6% downgrade to FY15 NPAT, and an 8% downgrade to FY16 NPAT. Our discounted cash flow valuation is reduced from $4.55 to $4.35 and we maintain our outperform recommendation (current price $3.23).

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CTI Logistics (CLX) – Expanding network (1H Result 20/2/14)

CTI Logistics (CLX) is poised to continue its very long history of creating shareholder value - with share price catalysts from the large LNG projects, an expanded warehousing and fleet network and the potential to un-lock hidden land value.

The courier business is mature and volumes are correlated with Perth business conditions. The business is flexible through its use of subcontractors and provides reliable cash flow to enable growth through the other divisions. The parcel distribution division is well placed to benefit from the shift to online retail sales. Line-haul freight services are expanding due to management’s focus on increasing its regional depots to enable a greater reach in Western Australia.

In regards to logistics, the division comprises warehousing and distribution, as well as servicing large LNG projects. Increased customer demand for contract warehousing and third-party distribution centre management has driven management to expand its capabilities.

The company has traditionally held a very low profile with minimal institutional shareholders – thus it was interesting to see the announcement towards the end of January that US-based global fund manager “Grandeur Peak funds” has become a substantial shareholder.

BHP has recently become a customer and it will an item of interest from the half year result to see if this relationship has progressed, along with other recent high profile contract/customer wins – Adelaide Brighton, Target, Nufarm, Thiess.

We have an outperform recommendation and $2.80 price target and valuation (current price $2.43).

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Pental – Back from the dead (1H result 28/2/14)

With a less restrictive balance sheet, it will be crucial to see that recent growth initiatives are gaining traction. The company is recovering from an extremely difficult period, where it had no financial capacity to invest in its products or manufacturing facilities, and the major supermarket retailers lost confidence with some of its key products taken from the shelf. 

While the company nearly lost everything, it certainly didn’t lose its branding advantage. All products are Australian owned and made, and many are the leader in their respective categories – White King, Country Life, Softly, Aim, Jiffy, Little Lucifer & Velvet. With at least one of its products in most Australian households, and the company now financially secure, it is easy to see why they are back in favour with the major supermarket retailers.

New CEO Charlie McLeish has hit the ground running, with branding and new product initiatives leading to an improved supermarket offering. There is also a long list of cost efficiency projects that have been identified, however management is currently being conservative with capital and ensuring a pay-back period of less than 3 years for any capital investments.

The recent expansion at its Shepparton manufacturing facility has also enabled the opportunity to win more private label tenders, and expand to other sales channels. Eg Mitre 10, the Reject Shop and hardware chain Masters.  

While FY14 will not see much EBITDA growth, the approximate $3 million savings from interest costs will nearly double net profit. Net debt has reduced from $70 million to $14 million in FY13, and is currently at approximately $5 million.

The recent media coverage of the automotive industry closures and the SPC bailout both highlight the pressure on the domestic manufacturing sector, with uncompetitive labour agreements and facilities that require investment and greater efficiency to be competitive. This recent news flow is very relevant for Pental, with one of its divisions closing partly due to a poor labour agreement and the company also suffering from not having the capacity to invest in its products and facilities for approximately two years.

Pental required a major capital restructure in FY12, primarily due to its oleo-chemicals manufacturing division in Port Melbourne. While the price of its main input product “tallow” became uncompetitive, another issue at the site was the very poor enterprise bargaining agreement. Pental has now closed and sold this site, and also relocated its bleach plant (produces White King) to Shepparton. The labour agreement in Shepparton is much more efficient, where the equivalent of five days work at the Port Mebourne site can be completed in three.

The fast moving consumer goods environment is likely to remain difficult, with Coles and Woolworths holding huge power over its suppliers. With the continued increase in private label, suppliers who are not the leader in their range are being squeezed from the shelf. Fortunately Pental is the leader of the category for many of its products (White King, Country Life, Jiffy, Sunlight etc). A lower Australian dollar assists against its competitors with imported products, and “Australian owned and made” is now becoming a greater focus for the major supermarket retailers.

With FY14 NPAT growth largely due to interest cost savings, it is FY15/FY16 where operational earnings growth will flow through. The FY15 price earnings ratio of 8.7 creates a mispriced investment opportunity, and continued evidence of the operational turnaround will act as a share price catalyst.

Further positive developments that should emerge include a less restrictive banking relationship, re-instatement of the dividend and share consolidation considering the excessive amount of shares on issue.

We have an initial price target of 4.6 cents, and long-term outperform recommendation (current price 3.4 cents).

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ToxFree Solutions (TOX)  – Expanding regional hubs – (1H result 25/2/14)

The focus of the result will be the operation performance of acquisition “Wanless” and management’s ability to integrate it with margin growth and cross-selling benefits.

Performance at key locations will be of critical importance. The outlook is very positive in Gladstone, and the Pilbara and Kimberleys were reported to be performing strongly at the AGM. 

The ownership of hazardous waste treatment sites creates high barriers to entry, resulting in low competition and high earnings margins (earnings before interest, tax and depreciation margins above 40%). The requirement of an Environment Protection Authority licence, and planning approval for these treatment sites, prevents multiple sites in the one location.

While the company has experienced excellent earnings growth, the company’s earnings also have a defensive nature due to industry contracts being long term (3-5 years) and its whole-of-project-life cycle exposure. This is especially relevant for liquefied natural gas projects, where services will be maintained or increased once the major projects become operational.

The industry mix is also of interest, with the group’s mining exposure likely to decrease from its FY13 level of 14%.

In summary, we are attracted to the mix of defensive earnings and high-growth opportunities at Tox. The barriers to entry from strategically located waste treatment sites with unique licences provide an excellent framework to expand its customer base and service offerings, both organically and by acquisition.

We have an outperform recommendation for TOX, with earnings and valuation under review.

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UXC Ltd (UXC) – IT cyclical rebound? (1H report 27/2/14)

In late December, the company downgraded FY14 earnings guidance, with a large second-half weighting. It will be important to see early signs of increased activity to ensure that guidance is maintained.

Longer term, the traction from recent acquisitions will be of focus, and particularly the “cloud” exposure through its new relationship with vendor ServiceNow. The other major growth opportunity is the exposure to Microsoft AX in North America – through its acquisitions of Cole Systems and Tectura.

UXC is now the largest Australian-owned ICT consultancy company, with more than 2,500 staff across its three key divisions – consulting, applications and infrastructure. The company’s ongoing vision is to be recognised as the leading Australasian IT service provider and the number one alternative to the big multinationals.

UXC’s differentiator is the applications implementation division, where management has developed very strong relationships with the key global Enterprise Resource Planning (ERP) vendors – SAP, Oracle, Microsoft, and recently cloud-based ServiceNow. There is a need for implementation partners such as UXC because the global applications vendors generally prefer to focus on the higher-margin development of their software. Furthermore, the software and infrastructure packages are usually very complex and require unique solutions to fit individual company needs.

UXC should be valued on a price-earnings premium to its listed peers, due to its strong partner relationships with the major applications vendors, its niche positioning in key growth regions, and continued margin improvement from the ongoing restructure.

We have an outperform recommendation for UXC, with earnings and valuation under review.

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