Milking Trash For Cash

We see good growth potential for Tex Cycle, backed by its bread-and-butter waste management division. Also, the kick-start of its waste-to-energy plant business should further help to propel future earnings. Moreover, its balance sheet is clean, carrying only minimal debt (net gearing of <0.1x). Besides, we believe Tex Cycle is eligible for a share listing transfer to the Main Market. The stock is trading at <16x PE, below local peers’ average, and below its five-year mean PE on a standalone basis.

WHAT’S NEW

• Company background. Tex Cycle Technology (Tex Cycle) was established in 1984 and is an industrial waste management company with services ranging from the collection, treatment, recycling, recovery and final disposal of the contaminant. It holds the licence to handle 31 categories of the 77 scheduled waste codes listed under the Environment Quality (Scheduled Wastes) Regulation 2005; this business makes up >90% of its total revenue. Besides, Tex Cycle supplies specialiaed items to the defense industry along with the trading of chemical products.
• Turning garbage into gold. Tex Cycle’s waste management business has been growing from strength to strength. In 2014, it shifted its operations to Teluk Gong from Puchong (4,089sqm) with a total land size of 31,906sqm. The total waste tonnage allocated (by the Department of Environment) to Tex Cycle to handle is 284,400 tonns per year (utilisation rate: 15-20%). Currently, it has over 5,300 registered customers, with the number steadily rising from 2,800 since 2013. The company chalked a 4-year revenue CAGR of 26% (2013- 17). In 2017, it bought another parcel of land (11,559sqm) at Teluk Gong for future expansion purpose.
• Electrifying its trash business. To further integrate vertically, Tex Cycle has ventured into the waste-to-energy plant business (it will be fuelled by decontaminated biomass, which is a by-product of its waste division). The agreement is to supply 2MW of electricity (total installed capacity of 2.5MW) to Tenaga Nasional (TNB) at a levelised tariff of RM0.4766 per kWh for 16 years. Operation is expected to commence by 1H19 (supposedly by Aug 18). The delay was due to switchgear installation hiccups, pending specification approval by TNB. It is anticipated to generate RM7m of annual revenue (assuming 68% efficiency rate) and RM2.5m of earnings (based on 35% net margin), implying an IRR of 11.5%, which could help lift overall bottom line by 27%.
• Riding on O&G recovery? Tex Cycle collects contaminated materials from companies in the electronic, engineering, automobile, O&G, printing and other manufacturing industries. Observing the O&G sector which has turned more vibrant, we gather that Tex Cycle has successfully acquired new customers in this space over the past 6-7 months. Hence, we expect a good financial showing from the O&G segment for the rest of 2018, albeit from a low base as it accounts for only 10% of total revenue. We reckon job flows here should stay relatively robust on the back of elevated crude oil prices, encouraging O&G activities to chug along.
• Revival of its military business? Despite being able to manufacture superior and competitively priced tactical military camouflage products, this business has been in a drought since 2009. We believe Tex Cycle was not in favour by Barisan National (the previous ruling government) but now with Pakatan Harapan in power, we understand management has started to receive tender invitation for its defense-related supplies. If all bodes well, there is a chance of a business revival in this sphere.
• Potential listing transfer to Main Market. After evaluating Tex Cycle’s financials, we find the profit tests for a transfer of listing under the Securities Commission’s Equity Guidelines were met: a) money-making for 3-5 consecutive years with an aggregate net earnings of >RM20m; and b) its latest annual net profit was >RM6m. Hence, we believe Tex Cycle is eligible for a share listing transfer to the Main Market. If this materialises, we believe it will help the stock to become more investable.
• Solid financials. Besides depicting a solid growth profile (top- and bottom-line grew at a CAGR of 26-32% from 2013 to 2017), Tex Cycle also has a sturdy balance sheet with a low net gearing level of <0.1x. If we were to include its liquid short-term investments into our calculations, the company will become a net cash entity. Although not a generous dividend paymaster (average payout ratio over the past five years was 15%, yield ~1%) and it has no formal payout policy, we are unperturbed seeing Tex Cycle is still residing at the growth phase of the industry life cycle.

EARNINGS REVISION/RISK

• Guidance. Management guides revenue to grow 10% yoy and net margin of 24-25% in 2018 (2017: 25%).
• Key downside risks include: a) slower economic activities, b) irrational price-base competition, and c) delay in rolling out its waste-to-energy plant business.

VALUATION/RECOMMENDATION

• A fast-growing waste management company. Tex Cycle is trading at <16x PE vs peers’ average PE of >20x. This is also below the stock’s 18x 5-year forward PE mean of 18x. Share price performance has trailed peers by 8ppt over the past one year.

Source: UOB Kay Hian Research - 18 Jul 2018