Sunday, November 8, 2015

800 Super Holdings - Waste management


Orientation


800 Super is a waste management company in Singapore. It has been in business since 1988 and was publicly listed in 2011. 



Large public sector contracts for waste collection, recycling, street cleaning, and lansdscaping tend to be awarded for 6 to 8 year terms and smaller, private and quasi-private sector contracts are awarded for one to three year terms.  



800 Super is one of four licensed, larger players eligible to bid for public waste management contracts.  






One might, as a first cut, weigh up the non-cyclical nature of the sector, ROIC, the counterparties etc and come up with a valuation that approximates 2x net operating assets less net debt as fair value for the equity, or $0.65/share. Or one could arrive at the same figure by using 9.5x trailing earning. Or one could compare 800 Super to its very close comparable peer, Colex Holdings, and come to the same conclusion. In any case, that's not a bad place to start. 



The opportunity



800 Super has been awarded (and re-awarded) major public sector contracts that are priced more attractively than the contracts that it had been operating under.  



For example, the Ang Mo Kio waste management contract was re-awarded to 800 Super in January 2014 and runs until September 2021. The predecessor contract (2006-2013) paid $1.05 million per month whereas the current contract pays $1.74 million per month. 



The Integrated Public Cleaning (or street sweeping) contract for the North East region, since lost, paid $0.52 million per month and has been replaced by the Integrated Public Cleaning contract for the North West region which pays $1.35 million per month. 


Since the cost of services -- supplies, disposal charges, sub-contractor fees, and labor costs -- haven't changed by nearly as much, margins should expand as should earnings.


So far, we have seen this
 



 drive margins as follows




and the investment case, such as it is, is that the next year should see the continuation, and indeed acceleration, of this trend:




If it turns out that way then 9.5 x $18 million in earnings values the equity at $0.94/share. 



If it doesn't work out that way for whatever reason*, 2016's earnings at 2H 2015 margins will come in at  ~$16 million and the equity, at a depressed multiple of 8x may be worth only $0.71/share.



So maybe 50% to $130% capital appreciation potential plus some dividends collected. 



Finally its waste-to-energy plant ought to be functional in 2017 and should, if nothing else, help cut its cost of waste collection services and therefore act an future driver of margin expansion.


edited to correct a table on 11/23/2015

*(I say for whatever reason but the wild card to watch is clearly labor cost. Singapore is labor constrained and one does see occasional spikes in labor cost as occured in 1H 21015)

Disclosure: I own some shares in 800 Super Holdings


43 comments:

  1. Glad you're posting more actively again, I enjoyed the read. Any reason you are picking 800 super over Colex?

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    1. Colex is useful in so far as confirming or disconfirming the case for higher margins but payoung out a flat annual 1/2 cent in dividends, well below the 30% minimum, is (1) deviant behaviour and (2) won't feed you. Plus I reckon that if Colex, with its substandard ROIC and payout ratio, deserves >8x earnings then 800SH does too. Plus Colex is painfully illiquid.

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  2. Wow...this is amazing stuff for a newbie like me. Please keep the posts coming!

    I thoroughly enjoyed your Flybe thesis. One question is - how do you decide how to size the positions? For instance, you sized your Flybe position over 20 times the size of 800 Super - what train of thought do you follow to come up with the sizing?

    Also, do you hedge against SGD declining when you invest in 800 Super?

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    1. Thanks for reading

      Sizing comes down to how much one thinks one can lose on the position, all things considered. So one has to have a feel for what the value drivers are and under what conditions they fail; what the back up sources of value are and how robust they would be in a bleak scenario. etc .

      knowledge about one's own emotional constitution is also important. Would you doubt the investment case -- the business model, the arithmetic, the macro scenarios envisaged -- If the share price is cut in half? One can be right and yet be frightened out of a position at a loss. Once can be wrong and go down with the ship. I think recognizing what's what and which is which comes with experience and one never achieves anything close to perfection. So some investors, faced with for example Coke at 5x FCF would say " wow, that's a once in a lifetime deal and size it at 3% and others would have the same reaction and size it at 30%.

      800 Super is a reasonably conservative pick and I think most people -- if they liked it in the first place -- would size it larger than they would Flybe.

      SGD weakens if USD strengthens andI own Nirvana Asia which is a beneficiary of a strong USD

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    2. Thank you very much for the reply! Airlines do seem to have more tail risk than a waste management company though, right? I mean look at Malaysia Airlines...someone somewhere probably thought Malaysia airlines was a good value investment right before the damn plane disappeared...or look at Volkswagen - no way an outsider (investor) would've seen that coming...The only way to mitigate those seems to be by sizing it appropriately...

      So in this case when deciding to size Flybe VS 800Super, shouldn't you keep a higher % of portfolio into 800Super?

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    3. That's quite right. I absolutely should.

      I should say, though, that Flybe is more robust than Malaysian or VW. They are just one name among many and the so-called switching costs are so low as to be nonexistent. Flybe's not quite like that. In its core routes it is the only alternative for an important share of the traveling population.

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    4. Speaking of switching costs...

      Is it better to figure out the NPV of the net income from the current contracts instead of capitalizing the profits with a multiple? I mean it's possible that Colex or Sembcorp or Veolio ES Singapore beats 800Super when it comes time to renew?

      Also do you have any details on the "OTHER" revenue (which you model as 40.8M in 2H 2016) ? How stable/reproducible are those revenues? Thanks.

      Delete


    5. "Other" is work for small private, semi-private and quasi-public entities -- the airport, zoo, etc and also office and aparrtment complexes, etc. Office cleaning, gardening, window washing, etc Lots of itsy bitsy contracts and these have shorter contract periods -- one year to 3 years.There's flux q to q although the medium and LT trends are up, obviously.

      WRT switching costs I think it's a little nuanced. Oligopolistic competition, for example, is good for each of the public sector buyers involved -- MHA etc . and each of the 4 players has at least some capabilities that the others don't have or don't have to the same extent.

      In any case, NPV of the current large contracts + multiple on traling average "OTHER" + liquidate the MRF and WTE facilities and one gets to the same place as applying a 9x multiple on 2016 earnings.

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  3. my spelling/typing is acerecently. apologies

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  4. Hi Red,

    Thanks for sharing your writeup and fantastic blog overall.

    I believe the IPC Southwest contract rate should be $2.44m/month (total contract value of $204.9m over 7 years). It looks like your $2.85m/month calculation is from assuming a contract life of 6 years. I'm forecasting around 9.5 SGD cents EPS for FY16.

    Apologies if I've missed something here.

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    1. Hi and thanks for reading. You're quite right: IPC SW ought to run at $2.4M per month. I have corrected the exhibit and correspondingrevenue/earnings/etc targets and valuations in the main body of the post. The "Other revenue" line is the remainder of Total Revenue less Large contract revenue. If you adjust your figures accordingly you and I should have similar earnings estimates for FY2016

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  5. Wages growing as a % of revenue by 2%p.a.+ really seems to be an issue here. It seems like they are also getting subsidized to the tune of 5m SGD by the Special Employment Scheme and the Wage Credit Scheme (the second of which might be reduced in the future if I'm not mistaken). Also the introduction of the "progressive wage model" seems to have caused a spike in wages in the cleaning industry. Do you have any thoughts on the impacts of these three developments, especially the progressive wage model? I am pretty comfortable with everything else here.

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    1. Also, do you have any guess as to the capacity / all in costs of the Waste to Energy plant, and potential cost reduction? My guess so far is its in the 30-50m SGD range.

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    2. Hi,

      Good questions, thanks.

      Labour costs have jumped up twice since 2008 -- in 2011 and 2013 -- and that, of course, is why the new/renewd contracts have been repriced. Over the next five years there will be some slippage and, at the end, the contracts will be re-priced again. The wage credit scheme applies to raises and the future subsidy will be 20% rather than 40% of wage increases and you can see that it is the implementation of the progressive wage model that caused the increase in wage credit scheme payouts in FY 2015. I'd take a mid-cycle approach and assume some labour cost slippage in the large,public sector contracts: is 4x multiple fair? No, right? So you could use anything between 7x and 10x and still see an attractively priced stock

      the WTE plant: I think they've spent ~30 million on it and there's probably ~5 million left to spend. The ROI depends on a number of technical factors but if I had to guess I's say something like 20 million a year in added profit::

      On the revenue side
      700,000 MT of incinerable garbage
      575 KwH per MT of garbage
      $0.225 per KwH = electricity price = shadow price

      on the expense side:
      $80/MT

      less capital costs & taxes

      There's time and room to see how this WTE plant works out since it's not at all baked into the share price

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    3. Thank you for your answers, thanks. I agree on the modeling of the wage credit part, as well as the multiple.

      Presentations like this one seem to indicate that the other 4 WTE plants in singapore have been quite a bit more expensive:
      http://hls-esc.org/documents/2hlsesc/04-2HLS_T1A_SolidWasteManagementSingapore_TeohSoonKay.pdf

      Getting my head around the economics and total costs of the plants is my final red flag here. If they indeed only have to pay an additional 5m SGD, that would be great. Also, wouldn't the 80SGD/MT expense fall away or at least decrease if they incinerate their own garbage?

      Finally, I wonder if the contracts have any inflation protection built into them. Seems with a fixed rate for eight years, rising labor costs as % of revenue might eat up your profits.

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    4. Please disregard the last sentence in my reply. I realized that you already addressed these in your reply. Thanks.

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    5. Well okay, let me break up my answer into two piles. economics and scale

      First the economics:

      575 Kwh x 1 MT x $0.225/Kwh electricity price = $129/MT in revenue
      Cost, we know is <$80/MT [the cost doesn't fall away; it is instead internalised and covered by revenue generation from electricity)
      Margin - 61%
      Max investment/MT for 15% ROIC = $330/MT

      Scale
      start with supplies and disposal charges in the income statement
      Divide by $80
      = MT of waste that 800 Super currently pays others to incinerate = 904 MT/day
      Implied MAX investment = $330 x 904 x 385 = $108 Million

      Third,

      Due to be operational in 2017. Is it likely that 800 SH will spend 1x its EV on the WTE plant within 12 months? esp without extensive discussion in the filings? I think not though reasonable minds can disagree. They appear to have told the one brokerage firm that covers them that WTE capex is "substantially complete".

      Either way, as above, the unit economics economics is unchanged - 15% pretax ROI.
      If we assume that capex = 40 then net benefit to FCF is 5 million
      If we assume that capex = 108 then net benefit to FCF is 16 million
      and so on

      That's why I gave it light treatment in the main body of the post. I lean toward the "substantially complete / $5 million benefit" narrative and, as I say, I don't feel a particular need to know which is what at the current share price.

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    6. I guess this is where I get a bit nervous. The size of the project matters to me due to debt sustainability. Also if this is true:
      http://www.singaporepower.com.sg/irj/servlet/prt/portal/prtroot/pcd!3aportal_content!2fcom.sp.SPEPCustomization!2fcom.sp.SP_Default_Framework!2fcom.sp.SP_Custom_Desktop!2fframeworkPages!2fcom.sp.SP_Custom_Default_Framework_Page!2fcom.sap.portal.innerpage?windowId=WID1332135032094&NavigationTarget=navurl://41c8e6a3faf48bb168af2c222faa8ee4&windowId=WID1332134938209

      then they can expect electricity prices more along the lines of 14.87c/KwH --> 85.5 SGD/MT
      I'm not sure whether the cost assumption of 80 can't be lower though. Isn't 800 Super currently paying other WtE plant operators to get rid of their garbage? Or are collection and gather costs a substantial part of these costs? In that case, margins might be wider than the implied 6%.

      With regards to three:
      I'm not sure about the filings, I found the wording in the brokerage report to be vague: "Capex for this project has already been substantially incurred, primarily attributable to the land that was purchased". Couldn't that also mean that mainly the land has been paid for so far, and only a "substanstial" but not a majority of the Capex has been incurred so far?

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    7. But again, thank you for the detailed answer, it's been very illuminating so far.

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    8. Remember -- the whole point of the investment in the WTE plant is to reduce their cost base. They're paying something in the neighborhood of $70 to $80/MT in incineration charges. They want that cost to come down and they think that the way to do that is to build their own incineration plant and not pay the profit spread to Keppel or KIT or whoever owns those assets now.

      So the conception of the project is that it has an IRR of >15%. Like any capital project there's a risk that it goes over budget but I haven't paid a dime for the land or cash that's going to be used to build the incineration plant so it is hard to imagine a negative outcome in the ordinary course of things.

      ps As a practical matter I doubt 800SH would be able to raise the funds to build a plant with the capacity that you're envisaging. No-one would lend them that kind of money and it seems to me too late to raise equity for a plant that's supposed to be operational in 2017.

      Having said all that, life's too short to invest in things that make one uncomfortable and no stock is likely to enjoy universal appeal.

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    9. What you say makes a lot of sense, and I fundamentally agree. Would just prefer to be 100% rather than 70% sure about this before this turns into 800 Super's 'Expansion into the Food Souvenir Business' story a year from now (though I realize there were other factors at play with FB, and I haven't given up on them yet!)

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    10. Ahhh you're in FB. I get it now:) Glad you're not giving up on it yet.

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  6. A friend of the blog has done some intrepid sleuthiing regarding the matter of the WTE plant. He tells me that management expects to invest in it in a staged manner and that its eventual or designed capacity is 432 MT steam per day and 67 MW of electricity. They say that they expect "substantial cost savings from the plant" although they wouldn't disclose detailed numbers.

    My thoughts:

    The eventual investment in a plant that size is going to sum to over S$100 million. The company will have run rate $15 million in net cash flow after dividends so it seems to me reasonable to suppose that the plant is built and operated in stages -- 1/4 of designed capacity made operational every two years or so;

    Unless the current 3rd party operators have been incinerating 800SH's trash at cost -- highly doubtful -- the investment in the WTE plant should be accretive both from an earnings and, eventually, an earnings multiple perpective.

    Getting into the energy business raises a whole new set of questions to think about. It will raise the margin of safety (in the final analysis it will be a tradeable asset independent of the current business) and, at the same time, introduce a set of short term uncertainties.

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  7. Interesting that your Singapore shipping position is more then twice as big as your 800SH position. Is that mostly because of the uncertainty the WTE plant gives? It seems 800SH is potentially cheaper in terms of earnings (or very similar at least)? Shipping business almost makes me a bit queasy. Is the 800SH stock mostly cheap because of uncertainty around WTE plant? Sometimes I struggle to see why people are selling the stock at these multiples.

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    1. Well there's no uncertainty around SingShip's RORO revenues and very little uncertainty about the FCF from those revenues. The logistics business is cyclical and will bounce around a bit. So the only thing that could (in theory) really throw off SingShip is client counterparty risk: if its clients go bust then the long-term contracts aren't worth much. But I look at NYK and the others and they look pretty solid to me. So v little risk, in my judgment, and SingShip would in any other year be a >15% position for me.

      There are more variables at play in 800SH. (1) Something like 25% of its regular business is re-competed annualy, (2) labor costs have been trending up, and (3) it is getting into the WTE business.

      More variables = more beta, at least, so there may be opportunities to add at lower prices. More variables = also more risk so smaller position allows one to add as uncertainties are resolved one by one or to exit if uncertainties turn out to be risks proper.

      Ordinary meanings gets mangled in investing. A low multiple (on earnings, assets, whatever) doesn't mean cheap. Instead, cheap is priced paid in relation to the present value of the money you'll get back on your investment. And that, in turn, is a function of business quality, time, management behavior, and payout policy. SingShip > 800SH on the first three and equals it in the last, in my view.

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  8. Hi, Just for info. I emailed the Company, and was told that the plant's designed capacity at this stage is only 2.8MW. However the Co declined to clarify my other queries on the WTE

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    1. Ok that makes sense to me. The "at this stage" is probably the crux of the difference between the alternative reports on their plans. Thanks for sharing.

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  9. Disappointing H1 2016 results. Increase in worker's wages is eating on the revenue increase

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    1. Disappointing is right. Marginal cost of labor = 68% of revenue so either this has become a fundamentally unsound business or there are some one-time mobilisation costs associated with the contract start ups. not enough information in the filing to know which.

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    2. Ok labor costs back in line via streamlining of staff count. The shares look set to earn $0.11 in 2016.

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  10. Hi Red. Thanks for all the valueable information.
    One question, don't you think they debt is high?
    Colex is conservative and 800 is too aggressive and the total debt t equity is 0.78.

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    1. I don't think the debt is high. The business itself is not cyclical, the interest payments are well covered, it can roll over its debt as it matures. If you think the incineration/recycling business is close to a utility the company should raise more debt as that segment grows/matures. That would be the responsible, shareholder-friendly thing to do.

      The risk/uncertainty associated with both these companies is the rise in labor costs (and the levies associated with non-resident workers).

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    2. Hi Red,
      May i know where you get all those valuable information like revenue recognition?
      I look at annual report but it doesn't show in the report. May i know where you get it?

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    3. Hi

      I'm not certain that I understand your question. Could you point me to a specific number as an example of what you're asking about?

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    4. Information like
      Ang mo kio - Toa payoh sector information.
      Where do you get such information from?

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    5. Okay. Their website and, separately, their filings with SGX have all of that contract by contract information.

      For example,
      http://800super.com.sg/about/news/29-news-1

      details Ang Mo Kio

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    6. Hi Red,

      Thanks for your prompt reply. Can guide me to get the contract information? Under which tab in SGX?
      I look at SGX, but still couldn't found any contract information details.

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    7. http://www.sgx.com/wps/portal/sgxweb/home/company_disclosure/company_announcements

      Choose 800 Super
      Choose year
      Choose "announcements"
      etc

      Delete
  11. Hi red, is me again . May I know how you calculate ROIC? As far as I know, it should be (net income- dividend)/ total capital. Your 2015 divided should be 1.8 instead of 3.6. Based on my calculation, 2015 ROIC is only 2.9%.
    Total capital : 108403000
    Net income : 4955000
    Dividend: 1788000

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    1. I calculate ROIC in the way that I've presented it in the second table in the post above: trade receivables minus trade payable plus PP&E.

      "As far as I know, it should be (net income- dividend)/ total capital."

      This is wrong and counterintuitive. The higher the share or earnings paid out as dividends the lower the returns on capital. I hope you can see that that makes no sense whatsoever.

      Q. What does return on capital mean and what is it used for?

      A. The investor wants to know how nuch of free cash flow needs to be reinvested in the business to generate an additional dollar of profit. Let's say that the business generates $10 of FCF today and you want to know how nuch you can keep and how much you'll have to reinvest in order that the business generates $11 of FCF tomorrow.

      If ROIC is 10%, you'll have to reinvest all $10 of FCF and the remainder -- what you can pay yourself in dividends as you're growing -- is zero.

      If ROIC is 20%, you'll need to reinvest $5 and you can pay yourself $5

      If ROIC is 100%, you can pay yourself almost all of the $10 and pnly have to reinvest a token amount.

      etc

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  12. Labour costs have jumped up twice since 2008 -- in 2011 and 2013 -- and that, of course, is why the new/renewd contracts have been repriced. Over the next five years there will be some slippage and, at the end, the contracts will be re-priced again. The wage credit scheme applies to raises and the future subsidy will be 20% rather than 40% of wage increases and you can see that it is the implementation of the progressive wage model that caused the increase in wage credit scheme payouts in FY 2015. I'd take a mid-cycle approach and assume some labour cost slippage in the large,public sector contracts

    waste collection services

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  13. Just read through the latest results. The easy money has been made on this, I think. $0.75 to $0.90 could be a hard slog considering what else is available.

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  14. Why do you think that their WTE plant will not be financially successful?

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