Transpacific: Interim result 2015

Transpacific's share price had increased 13% over the past month, which seemed strange given that earnings per share could fall 20% this year (see Transpacific Under Review).

Unfortunately the outlook is worse than that. Even if you strip out a long list of extraordinary items underlying interim profit fell nearly 50% to just $23m. That's precious little leftover from $700m of sales, which is why the share price has dropped 15% since the company announced its result after initially falling 17%.

Starting with the Industrials Division, the pain was widespread. With revenue from 60-65% of oil-related contracts tied to the oil price it's unsurprising that a 7% drop in revenue from the hydrocarbons division fuelled a 36% drop in profit. Collection volumes also fell 18% as Queensland mining areas produced less waste oil. The company is switching to fee based contracts, but it's unclear what impact this will have.

It's tempting to blame the poor performance on temporary factors like the lower oil price, but some of the lost revenue will be permanent judging by an associated $78m write off.

With the resources boom puffing out and Australia's massive LNG projects nearing completion, high margin emergency work remains low. Part of our initial investment case was that more emergency work could increase margins and profits. While that's still true, given the write off and our concerns that the resources boom could turn to bust as China's growth slows there could be more pain to come.

Cleanaway

Turning to the Cleanaway Division, which accounts for two thirds of the company's revenue and profit, things weren't as bad. Revenue and profit both fell 2.4%, with an increase in post collections revenue (revenue from what the business does after it's collected the waste) offsetting a fall in municipal revenue due to lower collections.

In summary the overall result was awful and management isn't expecting a recovery. The question is whether our initial investment case is intact and what action we should take, if any.

Our initial investment case had a few elements. We already mentioned the emergency work, but over time we expected new chief Bob Boucher to cut costs, increase market share by beefing up the sales team now that management can focus on the business instead of survival after fixing the balance sheet, and make tuck in acquisitions.

Not much has changed, though the $165m it paid Boral (plus royalties) for its Victorian landfill site was expensive despite the potential benefits it should bring.

The issue we're grappling with most is whether or not Boucher's strategy will be enough to overcome a slowing economy and a potential rout in the resources sector. If not our bear case of 60 cents per share could prove optimistic.

We're prepared to be patient, as it will be a couple of years before any benefit from the major landfill acquisition shows up. The company is also standardising its prices across Australia, so over the course of the year we should get a sense for Transpacific's pricing power, if it has any.

This move along with a host of other head office and operational initiatives will cost $14m in the period to 30 June. While that chews up more cash, the company's balance sheet remains in excellent condition and we're glad to see Boucher making long-term investments that should've been made by previous management.

What now?

In my nine years at Intelligent Investor I've always covered one problematic stock. First it was GPT Group, then it was Aristocrat Leisure and then QBE Insurance. Now it's Transpacific. This is the price you must pay if you want to beat the index.

In all those cases you could've made money after the steep share price falls. Transpacific has the added possibility, however small, that a larger company might buy it while the Aussie dollar is falling and load it up with debt. That's not generally a good reason to own a stock, but the share price has fallen so far that we're not wiling to let go when the company should be able to perform much better in a two or three years when Boucher's strategy has had time to work.

We're going to cut the prices in the recommendation guide, but please note that from here on the guide is indicative only, as the best course of action in our view is to sit tight and see how things pan out. That's unless the stock is a valuable tax loss candidate in your portfolio.

If the share price gets back toward 90 cents then we might consider selling out, but for now we're downgrading to HOLD.