Transpacific: Result 2015

The deeper you peer into Transpacific's full year result, the worse it gets. Revenue fell 27% to $1.4bn but, with the business shedding assets over the year, that was no great surprise. The EBITDA line starts to look bad, with a 40% fall to $230m, and net profit is worse again, down 55% to $98m – and that's without counting about $100m in writeoffs and one-off costs.

The Cleanaway business, which generates the bulk of revenue and profit, likewise didn't appear too bad superficially. Revenue rose 1.6% and operating profits were steady at $99m. Yet the aggregate numbers hid worrying trends.

Revenue from the commercial and municipal units, contributing 80% of Cleanaway revenue, was lower, and a worse result was spared only by an 18% lift in collections revenue, aided by the acquisition of a Melbourne landfill site. Management confirms that margins from Cleanaway are either rising or steady which suggests that volumes are falling.

The landfill acquisition was vital but expensive. Access to landfill sites allows operators to bypass increasingly costly waste fees but everyone in the industry is now following the same 'internalisation' strategy that Transpacific itself has outlined. Landfill assets are being bid up and we doubt this is a source of easy margin growth.

Industrials collapse

There is no salvation from the Industrials business either. Lower demand from the resources sector and the spectacular oil price decline smashed earnings down 60% to just $29m.

Earnings from hazardous waste removal collapsed 70% even though revenues fell just 7%. Higher margin hazardous waste removal has been replaced by lower margin non-hazardous waste work. The near completion of large LNG projects and a fall in project capital expenditures mean that this work will be hard to replace.

Less activity in the resources sector meant the minerals and remediation business reported a 60% drop in earnings and a halving of margins. With the sector under duress and miners all cutting costs, lost margin will be hard to recover. This is no mere cyclical funk.

We knew the hydrocarbon business would suffer as 60% of revenue is linked to the oil price. In the end, earnings fell 35% which, compared to the catastrophic falls elsewhere, wasn't too bad. Collection volumes, revenue and margins were all lower while attempts to introduce a fee-based payment structure rather than one dependent on oil prices hasn't made much headway.

Cash flow woes

After spending years with a bloated balance sheet that almost felled the business, it is worrying to see free cash flow weakening. Operating cash flow fell 20% to $176m, which isn't bad on cash receipts of $1.5bn. Yet the company spent over $322m on capital expenditure and other investing activities, so free cash flow was negative.

About $160m of that expenditure was for the landfill acquisition and the business has spent some money on growth projects but, even removing those sums, we estimate Transpacific must spend about $130m a year simply to maintain its asset base.

Transpacific needs to increase volumes to increase margins if it is ever to generate acceptable returns on capital. As a base case, it looks to be generating about $50m a year in free cash flow, which is simply not enough to make acquisitions to complete its strategy. It has also pledged to pay dividends and faces remediation costs of about $50m a year for the next five years.

There are simply too many demands on a limited, perhaps dwindling, flow of cash. We are unlikely to ever generate decent returns from this business and, following the recent restructure, there are few assets to sell or levers to pull.

Although net debt of $320m today isn't overly large, this time last year, the business held net cash. It's not hard to imagine Transpacific going down the same debt-laden path from which it has just emerged.

Hold or sell?

That's the case to sell. There is just one reason to continue holding: the entire domestic industry, dominated by five firms, faces the same problems. There is too much capacity and the industry is too fragmented to allow scale to work. Eventually there must be consolidation.

A key competitor, Suez, recently raised $1bn with the stated intention of making an acquisition in Australia. Transpacific's market capitalisation happens to be just over $1bn. With the fall of the local currency and weakening fortunes for Transpacific, the list of predators surely grows.

Although we think a takeover is possible, even likely, we see no reason for potential acquirers to rush and we don't wish to hang and watch the business decline in the meantime.

Transpacific has been a poor recommendation. We underestimated the cyclicality of the business and overestimated management's ability to improve things. We've also been slow to recognise our mistake. It's time to rectify that last bit at least. SELL.