EHL.AX - Emeco Holdings

[ukvalueinvestment]

I think the story is still intact, thought the write downs on held for sale equipment were a little larger than one might have hoped.

 

Management seem confident that the company is essentially sound.

 

I think margin of safety is still there.

 

Outcome will either be ok or very good, depending on whether Australian business comes back and obviously it's priced for worst case.

[Laxputs]

Is there a way to deduce the price in relation to BV that the assets were sold for? I don't see it mentioned. And the write-down on assets-held-for-sale doesn't say how many were held there to start or what price they were sold for. In total 71mm were sold and 40mm slated for FY15.

[Laxputs]

Shareholder call in 10 minutes. http://www.emecogroup.com/view/investors/asx-releases

 

...Waiting on the conference call the music playing is Aussie house--so obviously the results are going to be sick.

[yadayada]

wow some really good news. Utilization up a lot.

http://www.emecogroup.com/upload/pages/141120_ehl_2014managingdirectorsaddress/141120_ehl_2014managingdirectorsannualaddresstoshareholders.pdf?1416461284

 

[Laxputs]

I hope they are still making significant asset disposals and it would have been nice if someone asked about it. Utilization looks much better and long-term contracts in Aus and Chile. If they knock off a bit more debt I think there is a nice rerating around FY16 and a good IRR with high MOS.

[Max Alpha]

I know they have a guy employed to manage a small team to dispose of un-utilised equipment globally (mostly old equipment at the large end of the spectrum e.g. fleets of Cat haul trucks, loaders, large excavators etc.).

 

I spoke to him about equipment purchases a while back (we were looking for some smaller gear that they did not have available at the time) and he expressed to me that their key focus for the time being is getting the un-utilised fleet sold or back to work and they aren't straying too much from that. He sounded relatively upbeat about it and also said that utilisation had improved substantially.

[Laxputs]

That's interesting. Thanks. I've emailed IR so we'll see if they update.

[ukvalueinvestment]

I wonder how we should feel about fall in oil price, given that Canada is meant to be the healthiest bit of the business?

[Laxputs]

Is Emeco allowed to pay off their debt before 2019? Can they refinance? What does this wording in their notes to debt mean:

 

"These notes will remain fully drawn until maturity."

[yadayada]

Bonds trade 70 cents on the dollar. So they could buy them back for a discount. I dont think they trade on an exchange though?

 

And they can pay them back in about 2 years. Maturity is in about 4 years.

 

But with all around commodity collapse now, they really need to drive some efficiencies in the business to generate enough cash to buy them back.

 

Edit: no wait they are not callable. So they will build cash over the next 2 years, and they can call them in early 2017.

[Laxputs]

Earnings out. Guidance out. Investor Presentation and Conference Call.

 

It's a really interesting situation.

 

Margins took a big hit. Revenue FY15 is guided on par to 2014: ~240m. Earnings will back load 2hFY15. Adding back 12m in exceptional moving related costs, EBITDA margins were low 20%. They expect those to rise. Historical margins are ~44%. 2014 was 30%.

 

I see risk of permanent loss of capital as very low. At minimum, they need about 42m debt servicing costs and between 30 and 45m in sustaining capex. That works out to about 50% utilization rate and 30% margins. They are now at 74% UR and margins are trending up.

 

Suppose a dire situation, a global commodity sell-off, and they don't hit that minimum 72m they need to pay bills, they will likely be close and have 34m cash on hand and 75m financing available. They can survive for years with low UR and low margins without going bankrupt.

 

For this stock to offer 50-70% IRR, we don't need a recovery. We just need 70% UR and 30% EBITDA margins. They are now at 74% UR and trending up on margins.

 

Rental Plant: 518m

UR: 70%

Revenue 362m

EBITDA margin: 30%

EBITDA: 109m

Interest: -42

S-Capex: -35

Asset Sales: 35m

FCF: 67m

 

After 3 years Net Debt is about 150m. 5x EBITDA multiple is 550 EV. I have 77% IRR if it takes 3 years. I think that is a reasonable base case. Low case still shows upside. A full recovery and 90% UR and historical 44% margins is ~140% IRR.

 

Eventually S-Capex will turn into maintenance capex and then FCF will be lower. But if that happens it means biz is fine and the market will rerate the EBITDA to a fair multiple so it's moot. I called MGMT a couple weeks ago and they said they are targeting 40m of asset sales per year, 10m per quarter. 

 

I don't see permanent loss of capital at risk here. They have asset sales that are being sold close to BV last quarter. They have cash flows from Aus, Can, Chile in Gold, Iron Ore, Oil Sands, Copper. Adding CFO to asset sales and no debt covenants for a few years gives them room to weather the storm. And currently the outlook is trending positive. If they don't go under then it's hard to imagine a scenario stock holders don't see a high IRR.

 

Somebody poke holes in this or I am adding.

 

TIA

 

[lathinker]

 

Rental Plant: 518m

UR: 70%

Revenue 362m

EBITDA margin: 30%

EBITDA: 109m

Interest: -42

S-Capex: -35

Asset Sales: 35m

FCF: 67m

 

 

How do you get to 362mm in revenue, given they are guiding for 240mm? Looks a bit like you are assuming rental plant * utilization rate  = revenue? That would be flawed in my view as one dollar in assets do not translate to 1 dollar in revenue.

Also, yout FCF number is pre-tax. Is it correct to assume for Emeco to pay no taxes given losses in past years?

 

[Laxputs]

Right. I'm way off. I'll get back to that tmrw. Thanks.

[Packer16]

The results were in-line.  Given the $240m revenue projection, I get about $131m rev and $39.3m @ 30% EBITDA.  Annualized you are at $79m EBITDA and $42m interest expense gives you $37m FCF.  They have moved some there equipment around ramping up Chile and making Canada and Australia smaller.  The coverage ratio is now less than 2x, so there is good amount of leverage here.  They have executed on the increased utilization portion of there plan now comes the increase in EBITDA portion, a tougher nut to crack.  They have weathered the storm so far lets see if they can make it through to the other side.   

 

Packer

[yadayada]

Packer what do you think of HOS. Seems like a better business. Both EHL and HOS are in rental business (except HOS does boats, with a better moat) If oil turns up, both EHL and HOS will do well. But FCF will be 3-500m$ on a 730m$ market cap for HOS (since they are just past a massive capex cycle). And about 900M$ of net debt right now. And they do better in a down cycle.

 

As for EHL it seems they also have maintenance capex? That is in the range of 20-40m$?

 

If they get ebitda up to a 110m$, that is 70m$ of FCF, and probably 20-40m$ to maintenance, so about 30-50m$ of FCF to debt and shareholders. And 250-300M$ of debt. on a 75m$ market cap. So more debt to their FCF then HOS.

 

If you give both an 8x multiple (allthough HOS would deserve a better one then EHL), upside is slightly worse for HOS in the bull case, but you get a better business with less risk, and better capital allocators that will (and can right now) take advantage of a cheaper stock price to boost returns.

 

You really need 150m$ of ebitda (and a big recovery) to do really well with EHL, compared to other lower risk bargains out there right now.

 

and cost of recovery is lower for gulf of mexico, so their oil fields are at less risk of being shut down at current rates then the oil sands.

 

If you take an average on all the range of outcomes, really the only upside to owning EHL at current prices is diversification in commodities. But HOS is exposed to lower cost oil fields then EHL. And possibly  more upside if all those commodities turn up and they do 150m$+ in ebitda. But then in the bull case HOS could do 550m$ of FCF.

 

But there is more downside if things dont turn up for EHL. And their asset base is older then HOS, so they will need to incur more capex in the next 5 years if they don't want to erode their asset base. 20-40m$ of capex means they will barely have a business in another 10 years.

 

Cant figure out if i should just sell EHL at this point and buy HOS.

 

[Laxputs]

1. I can't find a realistic scenario where Emeco goes bust.

2. If they don't go bust, the most likely scenario is a high IRR, and that does not need an industry recovery to happen.

 

Survival Mode is 42m debt servicing. 0-40m S-Capex depending on assets used.

 

They have 34m cash. 75m financing. They are targeting 40m asset sales. They are selling assets as close to BV.

They can move assets to service Coal, Gold, Oil Sands, Copper on the three continents they operate in. They are continually looking for more industries to service in different locations (Peru is showing potential).

 

Say they need minimum 65m in EBITDA to not go bust. That would be a situation with UR much below current UR and margins well below historical averages. Their assets, cash, financing can let them muddle through the worst of storms for years. Obviously muddling through is not a good IRR. But it would allow them to survive, not destroy their asset base, and weather things until they trend upwards to higher UR and better margins (as they are now).

 

They are now attaining better UR of 74%. They did 50% UR in 2014 and 30% EBITDA margins. Looks like they are in low 20's % Adj-EBITDA margins 1h15 and ~30% EBITDA margins 2h15.

 

Eventually, they will have a sustained couple years of 70%+ UR and 30%+ margins. That puts them over 90m EBITDA. That is not the bull case. Bull case is historical 86% UR and 44% margins and based on much higher pricing than they are selling to customers now.

 

Their bonds are callable in March 2017. Most likely, their net debt figure will be reduced, perhaps ~270m. Renegotiating that expensive 10% interest rate will be a huge catalyst for the stock. Even 300m debt at 7% interest is 21m. They are paying 40m now. With 70-100m in EBITDA, that is extremely impacting on the bottom line and the resultant net debt figure in the following years and hence the rerating.

 

I'm getting 30-40% IRR with EBITDA going from 54m FY15 to 90m FY18 and corresponding Net Debt figures. I think that is a realistic and conservative low-mid case. Mid case is higher EBITDA based on higher pricing to customers with constant UR.  I'm getting similar upside modelling on a 35% payout ratio in 2018 and on 5x multiple of EBITDA in 2018.  A recovery to 85% UR and 44% margins is triple digit IRR.

 

Poke holes in this, please.

 

TIA

 

 

 

[Max Alpha]

1. I can't find a realistic scenario where Emeco goes bust.

 

I'm getting 30-40% IRR with EBITDA going from 54m FY15 to 90m FY18 and corresponding Net Debt figures. I think that is a realistic and conservative low-mid case. Mid case is higher EBITDA based on higher pricing to customers with constant UR.  I'm getting similar upside modelling on a 35% payout ratio in 2018 and on 5x multiple of EBITDA in 2018.  A recovery to 85% UR and 44% margins is triple digit IRR.

 

Poke holes in this, please.

 

TIA

 

I still think that the thesis plays but Q1 results were pretty ugly. You are right that this really is a binary scenario, if they survive their debt burden shareholders should do very well.

 

I think the major risk is that they are currently operating on extremely low margins and if they lose one or two major contracts and their utilisation drops again they will struggle to generate free cash flow. Fortunately they are now relatively diversified across several (currently beaten up) commodities and geographies.

 

The markets they operate in are extremely competitive with many contractors tendering work to earn a cash return on their assets with accounting profits well and truly out of the question. 

 

The other major concern is that in tandem with a shock to utilisation asset disposals dry up as management have disposed of the majority of non-core, hard to deploy assets, and begin to burn cash attempting to turn the business around.

 

Kenneth Lewsey sounds pretty no non-sense when it comes to generating a return for the shareholders, not falling in love with a broken business model, he is as invested as anyone in the outcome so I think the risk of this is low but is probably the easiest way to derail this story.

 

I think FY16 should throw off a comforting amount of free cash flow as they complete a full year with a respectable level of utilisation.

 

FY15:

UR: 75%

Revenue 241m

EBITDA margin: 30% in 2H

EBITDA: $56.1m = $16.8m + $39.3m = (131 * 30%)

Interest: -42

S-Capex: -30

Asset Sales: 30m

FCF: 14.1m

 

FY16:

UR: 75%

Revenue 265m

EBITDA margin: 30%

EBITDA: $80m

Interest: -42

S-Capex: -30

Asset Sales: 25m

FCF: 33m

 

Given the lack of covenants to worry about and 2-3 year time frame I am relatively confident that at least one of their beaten up core markets should start to turn and provide an opportunity for more profitable pricing of equipment during the relevant time frame (most likely a more stable oil price).

 

The book values of their equipment are very very low after the numerous write-downs since the commodities down turn started. The second hand market is absolutely atrocious in Australia and they are selling equipment at incredibly low prices and still not incurring large write-downs upon sale which gives me some confidence in these book values.

 

If they can retain their existing contract base in FY15 and dispose of another $15-$20m in plant I think they will be well on their way.

 

It will be a bit of a bumpy ride and is certainly not asymmetric like I feel some of the other bets I've made in the sector are (SDM.ax and LCM.ax), but barring another shock this half should be the turning point. Simply surviving will provide a multi-bagger.

[Laxputs]

Good post. Well written. Thanks for the contribution. I'll check out the two names you mentioned.

[60North Investments]

Emeco bought a truck and trailer rental company RentCo for $82m EV with $0-23m earn-outs based on 3 yr EBITDA targets. RentCo did in FY14 $45m sales and $19m EBITDA.

 

Pros I see:

-EV/EBITDA 4.3 not bad if RentCo is as stable as I imagine (i.e. $19m EBITDA reasonable or growing slowly)

-Diversification might be a plus

-Supposedly boosts EBITDA nicely

 

Cons:

-Not sure there's any meaningful cost or sales synergies at all, just need to hope it fits well still

-$11.4m worth of shares issued @ 12.6c/share, which comes to about 90m shares? Not too happy about that at this all-time low level

 

http://www.emecogroup.com/upload/pages/150313_ehl_acquisitionofrentcoinvestorpresentation/150313_ehl_acquisitionofrentcoinvestorpresentation.pdf?1426211337

[Max Alpha]

I think this has probably improved the bear worst case scenario through deleveraging and reduced the bull best case scenario returns due to the dilution.

 

Without having more details on the Rentco business financials it is hard to know whether this is a fair price. My thoughts are it is probably about fair value if the business has a young fleet in good condition. Many in the transport industry have come under pressure lately with several bankruptcies because it is still leveraged to the mining and LNG capex cycle in Australia and there has been some high profile safety incidents (Mcaleese Cootes Transport Fatality).

 

So in this market i'd like to think they wouldn't have overpaid for a transport business, they may be benefiting from depressed transport industry valuations across the board for a business with very little exposure to mining and LNG.  If it is a stable business and the earn-out targets involve high single digit CAGR of EBITDA then i think it is probably a fair price.

 

I am a little bit concerned about this as an approach to diversification though, as it is a very competitive commoditised industry with few barriers to entry. It is also more generally tied to the Australian economy which is facing slowing growth and some pretty big headwinds out of China.

 

So it could be a case of diworsification.

 

They don't talk much about synergies. Its great if the business is a viable investment without any synergies, but I hope that doesn't mean they aren't planning on benefiting from cost synergies. There would surely be many in purchasing, back office systems like payroll, invoicing, asset tracking and maintenance software systems etc.

 

I was hoping they might target something more niche with some stronger industry fundamentals, or a business which provides major synergies to their Emeco business.

 

The CEO owns a large stake in the business so he isn't interested in growing top line at the expense of shareholder value. Worst case I think this helps delever the business and provide a bit of a floor to the outcome at the cost of some dilution.

[Packer16]

Interesting news that Black Crane Capital and First Samuel want to nix the deal.  Black Crane is a skilled distressed and equity stub investor that has an about 5% stake in Emeco.

 

 

Packer

[Max Alpha]

That is interesting.

 

If you consider fair value to be in the 20 - 25 cents region then the effective EBITDA multiple is up around 5x which is expensive for a transport business in the current market.

 

Some small transport businesses with long term operating contracts have been selling at around book and between 3-4x EBITDA in the private market.

 

If Emeco went on to have a much improved second half and generate Free Cash Flow then this acquisition would appear to be fairly value destructive in terms of diluting the recovery story.

 

[Max Alpha]

Interestingly Black Crane have added to their position bringing it up to 7%.

 

This after it was reported last week management had cancelled their east coast investor road show to arrange an emergency board meeting to address the disgruntled shareholders.

[lathinker]

Settlement of the Rentco acquisition rescheduled. Management "in ongoing discussions with shareholders who have raised issues."

 

http://www.emecogroup.com/view/investor-articles/150331_ehl_rentcocompletionrescheduled

 

Will be interesting to see how this plays out...

 

[Guest chai]

Thought this may be helpful to the board. Attached is the presentation from Peter Kennan of Black Crane Capital on Emeco in a value investing conference yesterday.

asia15-peter-kennan.pdf