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Uncertainty Prevails For Tox Free Solutions

Small Caps | Mar 30 2017

This story features FORTESCUE LIMITED. For more info SHARE ANALYSIS: FMG

Waste business Tox Free Solutions will cease to service the Chevron Australia operations on Barrow Island at the end of FY17 and brokers are uncertain as to whether the company's earnings trajectory has troughed.

-Muted impact on earnings from the loss, countered by new contract gains
-Does this signal heightened margin pressure on other contracts?
-Daniels business envisaged on track but Worth may fall short of target

 

By Eva Brocklehurst

Waste treatment services Tox Free Solutions ((TOX)) will cease to provide services to Chevron Australia operations on Barrow Island at the end of FY17. While the contract loss is small, the news adds uncertainty to the outlook, brokers suggest, as it is unclear whether the company's earnings trajectory has troughed.

The company will continue to provide services to the other Chevron Australia operations under its master services contract. Re-tendering for contracts is always a risk, but Ord Minnett considers the earnings impact from this one is muted given Tox Free had been scaling down the Chevron contract over the past couple years.

The protracted re-tender process that was announced almost a year ago allowed much of the benefit from the high-value waste services from the construction stage to be retained by Tox Free. As such, the size of the contract from July 1, 2017, onwards is much smaller.

Given recent contract gains from the likes of Inpex, GLNG and Fortescue Metals ((FMG)), the company expects operating earnings will improve regardless of the Chevron contract loss.

The loss of the contract pushes out the trough in earnings per share to FY18, Morgan Stanley asserts, taking the opportunity to review assumptions. Morgan Stanley believed the company would be the natural winner of this contract, given its track record and existing assets on Barrow Island.

While the impact is relatively small, the broker suspects it foreshadows intensified margin pressure on other contracts. As there are no identifiable catalysts for a re-rating in the near term and the valuation appears full, the broker downgrades to Equal-weight from Overweight.

That said, Morgan Stanley's original outlook for improving earnings quality, growth and margin remains unchanged. The broker also acknowledges that the company's exposure to resources continues to reduce while the performance of the Daniels business appears to be on track.

The Barrow Island contract was the company's largest during the peak of construction in the resources sector, Macquarie observes. The loss of this part of the Chevron contract will affect FY18 operating earnings (EBITDA) by around -$1-2m.

Macquarie also re-assesses FY18 earnings estimates, noting that first half earnings fell $8.8m because of the decline in resource construction. For the company, this business was replaced by the Worth and Daniels acquisitions and $2.1m in organic growth.

Organic growth was led by the industrial services division that completed its first six months on the new Olympic Dam contract and also benefitted from east coast infrastructure work. The broker still expects earnings to grow in FY17 but suggests that Worth may fall short of its target as dry weather has affected what is largely a liquids business.

The broker expects, in all, that organic growth from recent contract wins in FY18 will be largely offset by the loss of the Chevron contract. While encouraged by the renewal of contracts in the core business, Macquarie requires earnings estimates to stabilise before becoming more confident and downgrades to Neutral.

UBS, yet to comment on the loss of the Chevron contract, noted the results last month fell short of expectations because of drier weather in NSW, the location being a significant contributor to the Worth business, and management abandoned guidance. The broker is undecided as to whether the stock has hit its cyclical low and suggests this is a question the market continues to struggle with.

There are four Hold ratings on FNArena's database. The consensus target is $2.31, signalling 0.1% upside to the last share price. Targets range from $2.20 (Ord Minnett) to $2.45 (Macquarie).
 

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