Does a valuable service mean a valuable company?
To society, waste management is a valuable service. Consider what would happen if your garbage wasn’t collected for a month. Unfortunately, servicing this critical need does not translate to sustainable long-term value for waste management companies.
Transpacific Industries (ASX: TPI) is one of Australia’s largest recycling and waste management companies. The Transpacific brand handles liquid waste, while the Cleanaway brand does away with solid waste.
The company has underperformed financially for many years, largely due to a sizeable debt burden amassed before the GFC. The company has since gone some way into improving its financial position – it has divested its New Zealand division to strengthen its balance sheet, and has also employed a new CEO who served as the Executive Vice President of Operations for Republic Services, a US$12.5 billion waste management company that is listed on the New York Stock Exchange.
These changes have been viewed positively by the market, with the share price appreciating by 50 per cent in the past 12 months. However, if you were to consider Transpacific as an investment, you should never lose sight of the business’s fundamentals.
You see, waste management is a capital-intensive, low-margin business. Due to the stability of the industry, it is highly competitive to secure long-dated contracts. While the service that is provided is critical, the client would have little concern over which operator takes away their waste, so long as it’s gone. Since contracts are secured on a long-term basis, it becomes critical to manage the cost base by working the assets efficiently in order to generate sustainable returns.
The new CEO has stated that Transpacific has a long way to go in order to achieve “best practice”. The CEO is drawing on his experience from Republic Services as a blueprint for Transpacific’s transformation. Historically, Republic’s return on equity has averaged around 7 per cent. This would certainly be an improvement on Transpacific’s return on equity, which has been close to zero in recent years. But if 7 per cent is the benchmark for best practice in the industry, it does not present a compelling long-term value proposition when an investor typically demands a return of 10 per cent.
At Montgomery Investment Management, we highly value our weekly garbage collection. But as investors, we prefer to invest in companies that have sustainable competitive advantages and can exercise pricing power accordingly.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
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Lloyd Evans
:
A 0% ROE with a view to hit 7%, that is about as compelling as TPI acquisition record.
I remember from a few years back TPI was the under bidder for the Cleanaway business. The purchaser – KKR, loaded Cleanaway up with debt and flicked it back to TPI shortly thereafter.
An acquisition hungry CEO who views the business as an extension of themselves (or their ego), rather than working for shareholders can be a poison pill for a company, However a leaky boat doesn’t help either.
Ben also raises an interesting point, if the company is generating 0% ROE with the industry benchmark of 7%, but the business provides a valuable service to the community, should the business hand back the keys (equity) back to shareholders?
Andrew Legget
:
As you have said, products and services intrinsically important to our quality of life tend to not show signs of quality that we look for in investments. I have previously discussed my needs vs wants hypothesis here before so won’t go into it again.
Companies such as the above tend to be commodity products and commodity products don’t make quality businesses that have a competitive advantage, quality brand and most of the time on top of this, good economics.