TOX's worthy acquisition

TOX recently announced the acquisition of Worth Recycling, a leading NSW liquid and industrial waste treatment and services business. The price was $70 million, with $50.4m funded by debt, and a $24m equity raising at $2.55 per share. With the waste and recycling company operating in weak markets, it would be easy to make the assumption that management is trying to fix an earnings gap. But, to the contrary, the earnings accretive nature of the acquisition, geographic diversification and greater exposure to the high margin hazardous division leads us to believe this is a very positive purchase for the company.

The FY16 pro-forma acquisition multiple is 5.4 times EBITDA, which is broadly in line with prior transactions. Worth's EBIT margins are expected to be 14-15 per cent in FY16, compared to TOX's forecast EBIT margin of 10.2 per cent. These forecast don't include further potential cost and revenue synergies.

After considering dilution from the capital raising, the purchase is expected to be 13 per cent earnings per share accretive in FY16. FY16 forecasts are increased by 4.2 percent, 15 per cent for FY17 and 11 per cent for FY18 with only conservative assumptions of $0.5m for FY17.

The strategy behind the purchase is to increase exposure to NSW, and the state now represents about 15 per cent of TOX revenue. Partly due to the resources downturn, NSW is now the largest and fastest growing waste market in Australia. Importantly, the acquisition allows TOX access to EPA licensed liquid treatment and soil remediation facilities. The hazardous waste division is Tox's strongest, from both an earnings margin and strategic viewpoint. Therefore it is a material positive to increase exposure to this division.

Unfortunately the TOX share price has already factored in the acquisition with a strong move over recent weeks. As such, we maintain our hold recommendation despite the valuation increasing from $2.80 to $3.10. The FY17 PE of 14, and dividend yield of 3.7 per cent currently represents fair value - with downside risks from weak resource based markets, but upside risk from the strength of TOX's business model.