A defining year

Four major contract wins, a successful equity raising, improved operating metrics and a small acquisition. Tox Free Solutions has had a big year and, more importantly, is well positioned to repeat its effort in 2011.

“As each contract rolls on, Tox gains in credibility and is nicely positioned to win further contracts”

Turning to the charts, Tox touched a low of $1.02 on December 9, 2008. From this level, Tox surged to a January 8 high at $2.80, which represents a gain of $1.72 (+168.63%).

Generally, after such an enormous appreciation in price, it is very normal for stocks to consolidate and retrace a portion of its gains. Tox has spent the last part of 2010 range bound between support at $2.05 and resistance at $2.80. Downside risk is limited to the $2.00 region should weakness in the short term continue.

A year ago, Tox was a small waste management company with plenty of potential but with plenty to prove to a market that wanted to see that potential turned into real contracts. Tox has ticked every box and successfully raised $25 million of equity as a genuine reward for delivering on its promises.

During the 2010 financial year, Tox nailed down four significant long term contracts with a range of large resource companies to manage their industrial waste programs. These contracts are worth an additional $78 million of revenue to Tox over the next three years. Importantly, it will more than double the amount of contracted work from 15% of revenue to 36% and therefore, reduce the amount of seasonality of the business and lift the consistency of earnings in the forecast period.

As each contract rolls on, Tox gains in credibility and is nicely positioned to win further contracts. The pipeline looks reasonably promising in this regard, but we are not attributing any value to promises.

Potential new contract wins aside, Tox has plenty of work now on its plate to ensure it delivers on the recent contract wins. Among the contracts is a waste management contract for Toll Energy at Barrow Island, contracts with Rio Tinto, Boral Cement, Woodside’s Pluto development, and the Murrin Murrin nickel refinery.

Tox’s existing industrial, liquid and solid waste businesses will also benefit from better operating efficiency as the boosted management team gets stuck into those issues. A large effort has been made to improve management systems over the last 18 months and this should begin to pay dividends across the next year and beyond.

2010 Result

Revenue increased 11.8% to $98.6 million which helped increase operating profit (EBIT) by 10.9% to $16 million. Net profit therefore increased 24.3% to $9.2 million driven by a slightly lower tax rate of 28% and a smaller debt position following the capital raising.

By division, Industrial services, solid waste and hazardous waste reported approximately similar EBIT contributions between $6 million and $7 million. Liquid waste at $3.8 million is the company’s fourth division. The award of the new contracts and the inclusion of these during the year make comparison with the prior year less meaningful, but we expect another steady improvement in FY11 from each division.

Industrial Services provides onsite waste collection, tank and drain cleaning, high-pressure water jetting and liquid and industrial waste management services. The new Rio Tinto contract will significantly boost revenue from FY11 by about $7 million per annum. The Murrin Murrin contract is worth around $6 million per annum and Boral Cement about $2 million each year.

Hazardous Waste services are provided from Perth, Karratha, Port Hedland and Kalgoorlie in Western Australia, with a Brisbane operation also part of this division. Karratha is now the biggest contributor to this division as industrial activity increases throughout the region.

The Solid Waste division was arguably the best performing division in FY10. The big increase in revenue and EBIT was achieved through the provision of services to Woodside Petroleum and Toll Energy. The new Pluto LNG development is scheduled to commence in the third quarter of 2011 and Tox will also provide waste management services to this Woodside project.

As Tox develops its Pilbara Resource Recovery Centre in Karratha, it is becoming even better placed to participate in the steadily growing solid waste industry in WA.

The Liquid Waste division experienced volume shrinkage at the Kwinana and Brisbane plants. Revenue dried up by 25% as a consequence. This division is more exposed to the manufacturing side of the Australian economy which highlights both the extraordinary growth in the resources sector and the comparatively staid growth elsewhere.

Financials

Tox successfully raised $25 million in equity capital this year. We recommended members participate in the Share Placement Plan at $2.30 in December 2009 (FAT453), alongside the institutional placement at the same price.

The capital raising substantially boosted the balance sheet which ended the financial year with net debt of $13.1 million and shareholders’ equity of $88.5 million.

Net operating cash flow for the year nearly doubled to $17.6 million, enabling capital expenditure of $20.9 million to get some of the major contract wins underway. Capex for FY11 will be slightly lower around $18 million. The company paid a maiden dividend of 2 cents per share.

The weekly chart illustrates the strong surge higher from December 2008. Tox respected the 39 week moving average (green line) at $2.43, which could potentially result in a test of the 200 week moving average (red line) at $1.96 in the near term. The short term retracement looks to be corrective. Whereas the uptrend in place coupled with the bullish moving average cross bodes well for a continued move higher over the longer term.

Outlook

Much of Tox’s revenue and earnings growth in FY11 will come from the new contracts as they progressively ramp up. The company should generate good organic growth as well, meaning this year will be a transition year towards a larger but more consistent earnings base.

The potential for more contract wins is evident, particularly as Tox establishes its reputation as a proven performer in these large and specialised contracts.

The WA resources sector continues to provide the best opportunities for Tox but further small acquisitions may also prove worthwhile.

We continue to like the company’s prospects, so Tox will remain held in the Fat Prophets Portfolio.