800 SUPER: 3Q results not great, but next leg of growth has arrived

"Money Plant" contributed this article to NextInsight. A  retail investor, she owns shares of 800 Super.

800 Super reported a 16.7% fall in profit on the back of a 2% drop in sales in 3QFY17. If we look at the 9M results and back to 3QFY16, things may not be as bad as it seems. I will explain why below, but note that 9MFY17 results are still up 15.6% yoy.

Results overview:

3QFY17 sales dropped 2% yoy (about S$0.8m drop) mainly due to the completion of certain cleaning contracts. This was a high bar to beat in 3QFY16 where sales rose 8.3% yoy (S$3m rise then). 

While it’s unfortunate that employee expenses increased 9.3% (S$1.5m) – the main reason for the fall in profit yoy -- it was due to a decrease in the government grant under the wage credit scheme (S$2.7m). This was partially offset by a decrease in salaries and bonuses of S$1.1m in line with a lower headcount.

The sales drop was only S$0.8m but the decrease in salaries and bonus was S$1.1m, suggesting that the group must have either won some contracts to offset the fall in sales from the completion of certain cleaning contracts, or has lowered labour costs even further.

Without the impact of the lower grants from the wage credit scheme, the underlying cost management is actually very good :)

Other signs of good cost management as mentioned in 3QFY17 report:

♦ Purchase of supplies and disposal charges (- 6.8% yoy) due to better cost management.

♦ Other expenses (-7.2% yoy) due to decrease in foreign worker levies in line with a decrease in foreign worker headcount from completion of certain cleaning contracts as well as an increase in productivity from technological initiatives undertaken by company.

So all in all if we look at 3QFY17 results:

 ♦ Sales dropped S$0.84m BUT

♦ These 3 expenses alone already dropped S$1m (more than offsetting the sales drop during 3QFY17):  Purchase of supplies and disposal charges dropped S$0.44m; Sub contractor charges dropped S$0.14m; Other expenses dropped S$0.41m;

Main culprit for the profit drop on a yoy comparison is

♦ the employee benefit expense - which was mainly due to lower grants from the wage credit scheme- something not within management control, but they have done well to contain it as mentioned above- the best scenario you can expect from a situation like this. 

♦ rise in depreciation (S$0.23m) due to a new truck depot at Tuas to support the group’s expanding business operations. But this is a good sign that the group is expanding.

Looking ahead: 

New revenue streams to be expected:

♦  Development of WTE plant at Tuas south expected to be completed in 2Q17 – which will provide green electrical energy to the depot and to be completed sludge treatment facility (2Q18), generating new revenue streams and cost savings to the group. 

♦  Sludge treatment facility targeted to be completed in 2Q18 – which will treat and dispose sludge from water reclamation plants operated by the Public Utilities Board. In 27 Oct 16, 800 Super was awarded a S$133.65m contract by PUB to treat and dispose sludge from water reclamation plants from 7 Nov 16 to 6 May 2032. 

We do not know what is the capacity of the sludge treatment plant (as we did not meet management) but the capex for the facility is S$53m.

Nothing to lose, but everything to gain if there is a pleasant surprise.

There are currently 4 public waste collectors (PWC) in Singapore. In 2018, the 7 sectors will be consolidated into 6 - with the new contracts for Pasir Ris-Tampines and Bedok consolidated and commencing in 2018.

And the investment merits:

♦  High earnings visibility- Multi year contracts that provide strong earnings visibility

Based on the contract announcements we can collate from the market, the multi year contracts (on a back of the envelope calculation) may help to contribute S$79m in sales/year to 800 Super, about 50% of FY16 revenue.

* Note that disposal of sludge has not contributed to 800 Super yet, since the facility is still under construction.

♦   Potential for new revenue streams (Waste to energy plant from 2Q17, Sludge treatment plant from 2Q18, potential for pleasant surprise if they win the PWC contract in Pasir Ris-Tampines-Bedok).

♦  Defensive business- Waste management, cleaning (needs no further elaboration).

♦  HIGHLY CASHFLOW GENERATIVE business – est 7% (and even more going forward) free cash flow yield (excluding expansionary capex in 2016). 

While it may not be that obvious now due to the heavy CAPEX plans by 800 Super in the recent years and next year for the sludge treatment, but we see these current heavy CAPEX plans very positively as these are seed planting for 800 Super’s next leg of growth.

Anyway, (back to cashflow), the underlying business of 800 Super is highly cashflow generative, and will be evident once the heavy CAPEX plans are completed. 

So simple “guess-timation” of operating cashflow (OCF) is typically net profit + depreciation (ignoring all the effects of trade receivables etc- hopefully no bad debt since they are mainly serving the government) For eg. FY16 “guess-timated” OCF is S$24.9m (reported OCF is higher at S$32.7m- but its ok) 

Note that there was heightened CAPEX in last few years due to construction of WTE plant (which cost about S$31m- started since 2015, should be almost done now, 2013 CAPEX was also high due to the purchase of land from JTC)

We do not know what is the maintenance CAPEX of the group, but given that this is still a labour driven business, we do not expect CAPEX to remain as elevated as in 2015-2016 after 2018 (after the sludge facility is completed and barring any other expansion plans).

For the “normal” years like 2011-2012, 2014, we note that for every $1 of profit earned, 800 super spent about S$0.36-0.52 back in CAPEX, but of course note that profit base then is low (so the % is also larger, and this is just an estimation). 

But in any case, assume a 40-50% CAPEX spent per $1 of profit earned (for sake of being conservative), using FY16 as an example, we “ guess-timate” maintenance CAPEX to be about S$7-8m. Our FY16 “ guess-timated” OCF is S$24.9m (reported OCF is higher at S$32.7m- but its ok). 

Our “ guess-timated” FCF for FY16 (excluding expansionary capex) is about S$17m. On a market cap of S$245m (based on price of S$1.37) it is a Free cash flow yield of 7%!!!! – and this is just in “normalized FY16” – we are not even talking about those growth plans ahead for the group above (Free cash flow is the amount of cash that the company generates after operations and maintenance CAPEX that can be used to return to shareholders as dividends or for M&A in future) 

My TP is S$1.58-S$1.80 based on 14-16x FY18F PE (which we assume about a 10% growth from FY17 see above). – which we don’t think is unreasonable given the strong earnings visibility, strong cashflow generation in the future, and defensive business nature. 

While 800 Super is expensive relative to its local peers, but it is much larger in terms of ( market cap) size. It is also  trading at least at a 15% discount to its international peers- but of course it is also much smaller than them. However given the group’s potential strong cash flow generation in the future, strong earnings visibility (half of contracts are on multiyear), strong growth pipeline (waste to energy plant, sludge treatment) , we think 800 Super is ready for another leg of growth in the next 2 to 3 years,  in this unlikely boring yet defensive sector.