Monday 3 July, 2017 The Cane Toad

Monday, 3 July 2017

Shareholder apartheid?

In late May and early June I was in a far smaller crowd than this one at Suncorp Stadium yesterday, when a few big legal brains went for a gallop around Federal Court Room 18B in Sydney, to sort out Perpetual’s op-pression case against Brickworks and Soul Patt’s. And while I leave the merits of that particular shareholder apartheid encounter to be decided by Her Honour Judge Jayne Jagot, I did notice a few things along the way. Firstly, I loved the reference by Perptual’s advocate-in-chief, and Rabbit-oh’s tragic, Tony Bannon SC, that “waiting for Brickworks to address the corporate structure, is like waiting for Godot”. I also enjoyed the soaring hyperbole of Soul Patt’s advocate, Noel Hutley SC, referring [tongue-in-cheek] to Her Honour as the “Central Committee” in some “Stalinist” re-gime. But what I really liked was that our approach to analysing the corpo-rate structure, in particular the way we have consistently navigated the circularity of the cross shares between Brickworks and Soul Patt’s, was reviewed and endorsed by advisers to Brickworks, as far back as 2011. But it’s unlikely we’d ever have known this, except it seems for the op-pression trial and the evidence which was discovered along the way. So whatever the result (which I’m told we might know in the next couple of months), credit not only to the AFR, which devoted substantial time and talent to bringing the shenanigans to a wider audience, but also to Perpet-ual, for having what was described from the bar table, as the “means, for-titude and sense of principle” to take the shareholder apartheid battle up to Brickworks and Soul Patt’s. But oppression wasn’t the only legal wrangle weighing on Soul Patt’s in June, as it suffered a stinging defeat in the Queensland Land Court, when its New Hope subsidiary was unexpectedly denied the opportunity to ex-pand its coal mining operations out the back of Toowoomba, at Acland. Judge Smith certainly didn’t hold back, stating, among a raft of criticisms of New Hope, that: “[New Hope] may have acted within the letter of the law…..but as an example of engagement with the community, [New Hope] has acted quite intentionally like a bull in a China shop”. I’ve never seen a bull in a China shop, but I doubt the metaphor was of-fered as a compliment to the Soul’s empire, which looks like it savours a stoush even more eagerly than yesterday’s worthy champion at Suncorp Stadium, Jeff Horn.

Please enjoy this Toad as much as we enjoy bringing it to you.

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Inside this issue...

Editorial................................................ 1

Motorcycle Holdings - Leaning in ............................................ 2

Tatts Group - ACT sees the light ............................... 2

Eureka Group - Acquisition activity cranks up .............. 3

National Veterinary Care - A capital idea ....................................... 4

Cleanaway - Bingo? ................................................. 4

Soul Patt’s - Business as usual ............................... 5

Cane Toad Index Wrap ....................... 6

June Market Summary ........................ 7

Queensland Movers ............................ 7

Company Visits Register ..................... 8

Issue 184

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170The Cane Toad Qld20 Accumulation Index

Monday 3 July, 2017 The Cane Toad

Motorcycle Holdings - Leaning in

In the Toad’s unrelenting search for underappreciated and undervalued Queensland companies, no stone is left un-turned as we scour the state for that winning blend of quality, value and growth. And we recently uncovered such a company in the nuts and bolts only Brisbane sub-urb of Slacks Creek, a company called Motorcycle Hold-ings (MTO). MTO had humble beginnings, initially operat-ing just one motorcycle dealership in Moorooka in 1989, before growing through consolidation across the past 28 years to become the largest dealership operator in Aus-tralia, with 42 franchises across 27 locations. The guts of the business is still in the sunny state, where it owns 23 locations, but it also has a presence in VIC, NSW and ACT. Driving this growth was David Ahmet, who co-founded the business and who remains CEO, with a 22% shareholding. Indeed, neither David nor the executive management, who hold an average tenure of 14 years with MTO, sold a share in the May 2016 $2.00 p/share IPO. And we believe the good story will continue, and see many years of growth ahead for the business, both through organic and acquisition-led initiatives. In particu-lar, some of the key positives which underpin the Toad’s investment thesis include 1) positive industry trends, un-derpinned by improving new road motorcycle volumes, a solid core QLD market, and overweight Harley-Davidson position (which has been the best performing brand by a country mile – maybe boosted by retiring baby boomers?); 2) strong outperformance compared with the market, where we estimate MTO achieved positive growth in 1Q17 against the market which was down c. 13%, demonstrat-ing it is not a slave to market conditions; 3) its superior EBITDA margin to its car retailing automotive peers ap-pearing sustainable based on differences in sales mix, with potential for margin expansion longer term; 4) a com-pelling bolt-on acquisition strategy, supported by a highly fragmented industry (there are only 4 others operators with more than 2 dealerships aside from MTO out of 700 dealerships nationwide) and where a relatively small amount of acquisition spend can be materially accretive to EPS given relatively low acquisition multiples and the syn-ergies MTO is able to extract from dealership purchases; and 5) an attractive EPS growth profile, with a forecast EPS CAGR of 11.0% across FY16a-FY20f. But the Toad also interrogates the downside, and notes that the main potential drag on near term earnings is a reduction in commission revenue, owing to changes to add-on insurance products which MTO sells through its dealerships, following ASIC’s inquest into the sector. And our forecast assumes a 50% reduction in premiums across the three relevant insurance products, and a reduc-

tion in commission rates from 50% to 20% on two of them. This implies a $2.0m reduction in commission rev-enue, and $1.5m reduction in EBITDA from FY19. We expect MTO will pursue strategies to mitigate this poten-tial impact, including selling more accessories and higher attachment rates, and while we understand it’s likely MTO will be able to recover a material amount of the re-duction, we have not included any benefit from this in our forecasts. And so following some thorough DD, the Toad leans in to initiate coverage on MTO with a Buy recommendation and $4.58 p/share DCF based valuation. At $3.94 p/share, MTO is trading on an FY17f PE of 16.2x, falling to 12.4x by FY20 and a dividend yield of 3.1% ff in FY17, rising to 4.0% ff in FY20. Tatts Group - ACT sees the light

There was big news last month for TTS and TAH share-holders, when on 20 June, the Australian Competition Tribunal (ACT) saw the light and granted authorisation for the proposed merger between Tabcorp (TAH) and Tatts Group (TTS). ACT president Justice John Middleton said that ‘the Tribunal is satisfied that the proposed merger is likely to result in substantial public benefits’, while ‘the public detriments identified by the ACCC and interveners are unlikely to either arise or are not of significance’. The only condition the ACT overlaid on the decision was for the divestment of Odyssey, which has been addressed by TAH since the ACCC flagged this as an issue earlier in the year. This means now that TTS shareholders are expected to convene in August to vote on the proposed merger scheme. Unless, on which see below….. TAH also snuck through a sizeable downgrade in its an-nouncement on the approval, advising FY17 EBITDA and NPAT will be between $2,220m-$2,240m, $500m-$510m, and $173-$180m respectively. This compares with con-sensus revenue and EBITDA of $2,286m and $538m prior to the announcement, implying a 2.5% and 6.1% downgrade at the mid-points respectively. TAH pointed to one-offs such as unfavourable weather and increased opex ahead of implementing the merger with TTS to ex-plain the weakness, however the market took a more pessimistic view, marking down the TAH share price by around 5% by the end of the month. In our view, the ACT approval, and the surprising lack of conditionality, significantly changes the landscape and means it is now a two horse race between TAH and the Pacific Consortium (PC) to win the bid for TTS.

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Monday 3 July, 2017 The Cane Toad

tion, on 24 May, EGH appointed ex Devine and Affinity finance man Paul Cochrane as CFO, effective 28 June, to replace Ryan Maddock.

And just last week, after 7 months with no acquisition announcements, the company announced it is buying Freshwater Villas, a 42 unit retirement village located in the bucolic Mary Riverside township of Gympie, just 45 minutes north of Noosa, for $4.0m, and a smaller village in golfer Karrie Webb’s home town of Ayr, in North Queensland, which will cost $1.0m. They are both ex-pected to initially generate an annual return of 10-11%, implying annual EBITDA of $500k-$550k, and will settle early in the new financial year. Apart from this, the company also outlined that there are a further two villages in final stages of DD, and we have forecast 4 villages to be acquired in FY18, excluding the two announced last week, representing an additional cash spend of $12.0m, which compares with manage-ment’s target of 8-12 village acquisitions. Management also flagged that approvals for its large and highly prospective Terranora development are progress-ing, with the DA and titles expected ‘in the next few weeks’, from late June. EGH is currently holding $8.2m in contracted sales at the project, subject to the titles be-ing issued. We have adjusted our earnings forecasts for Eureka to reflect last week’s acquisitions, as well as higher corpo-rate costs in 2H17 reflecting the CEO and CFO recruit-ment related expenses. This has resulted in EBIT down-grades of 5.1% in FY17, and minor revisions to our FY18 and FY19 forecasts. We also point out that the FY17 result will include acquisition costs associated with the Gympie purchase, but almost no income from this. Also, our estimates do not include any proceeds from the Ter-ranora redevelopment. We continue to like EGH for its defensive rental income cash flows, ample acquisition runway for freehold rental retirement assets, and the positive long-term demand profile for its affordable and transparent accommodation offering. At $0.37, EGH is trading on a forecast FY17 EV/EBIT multiple of 15.9x, falling to 11.3x in FY19. We have not forecast the company to pay dividends across the fore-cast period. We value EGH at $0.52 p/share based on our DCF valuation and we maintain our Buy recommen-dation.

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To reflect this, we have adjusted our decision tree frame-work and increased the probability that TAH prevails to 50%, up from 20%, with the probability for a competing proposal now 50%, down from 80%. We continue to as-sume a TTS price of $4.34 p/share if TAH prevails, re-flecting a TAH share price of $4.89, which is consistent with the implied TTS price on the day of TAH’s initial pro-posal (19 October 2016) as well as the price TAH paid for its 10% shareholding in TTS on 25 November 2016. It also reflects our strong conviction that the TAH share price would firm from current levels if a competing pro-posal does not arise. While not incorporated into our de-cision tree, we also highlight potential upside for TTS shareholders post-merger, where we calculate a TTS val-uation of $4.67 p/share based on our TAH SOTP valua-tion of $5.30 p/share. This implies 8.1% upside to the cur-rent TTS share price. On the other hand, we rate it an equally likely outcome that there will be a competing proposal. The most proba-ble outcome here is a revised proposal from PC, which we value between $4.24-$4.57 p/share. The other, and still the most economically rational outcome in our view, is a revised proposal from PC and TAH, to offer an estimat-ed $5.09 p/share, based on 18.0x FY18f EV/EBITDA for Lotteries and 9.0x EV/EBITDA for Wagering & Gaming (post synergies). Such a result would maximise share-holder returns for at least two important stakeholders, be-ing TTS and MQG shareholders. (TAH might argue the toss on that though, given its looking to buy the TTS Lot-teries business below tote odds under its current pro-posal). So, following the authorisation of the TAH/TTS merger by the ACT, and subject to the receipt of final regulatory ap-provals, documents are expected to be distributed to TTS shareholders mid-July ahead of the Scheme meeting in August. This timing could mean that any competing pro-posal will emerge before the next Cane Toad is inked. So while the finish line is in sight for TAH, we believe TTS remains in play, and based on our decision tree frame-work, we value TTS at $4.50 per share (prev. $4.58 p/share), 7.6% above the current share price, while the up-side could be as high as $5.63 per share, a premium of 34.7%. At its current share price of $4.18, TTS is on an FY17PE of 26.5x, falling to 24.5x by FY19, and a fully franked dividend yield of 4.1% for FY17f, lifting to 4.2% by FY19f. It remains a Buy. Eureka - Acquisitions activity cranks up It’s been a turbulent 6 months for Eureka shareholders, with the share price broadly halving in value since the release of a worse than expected first half result, owing mainly to weaker occupancies and higher costs at a num-ber of villages. Since then, management, led by well cre-dentialed CEO Jeff Weigh, has been working to restore portfolio occupancies and get operating costs back in check. Early successes have been achieved, and the Toad now understands that underlying portfolio occupancy has im-proved from around 86%, to closer to 90%, over the last few months, while of the three troubled villages in South Australia, key detractors from the 1H17 result, two have demonstrated better performance through 2H17. In addi-

Monday 3 July, 2017 The Cane Toad

We remain attracted to NVL as management continues to execute well on both organic and inorganic growth opportunities, backed by strong cash generation. Fur-ther, industry profitability continues to benefit from posi-tive trends in veterinary wage inflation, rising average spend p/pet, and stabilising pet populations. The Toad’s DCF based valuation has risen to $2.81 p/share (prev. $2.73 p/share), implying upside of 19.1% to the current share price. At $2.36, NVL is trading on a FY17f PE of 19.4x, falling to 14.0x by FY19, with a fully franked yield of 0.7% in FY17, rising to 1.8% in FY19. We maintain our Buy recommendation. Cleanaway Waste Management - Bingo? It’s been a frenzy of activity in the typically sedate waste management industry over the past two months. Early on in May, we saw the successful ASX listing of Bingo Industries (ASX:BIN), the NSW leader in building and demolition waste management that has grown rapidly on the back of the construction boom in Sydney across the past few years. And although the price fell below its IPO price on day one, it has managed since to recover, and at least got the listing away unlike some of the other high-profile IPO hopefuls such as Craveable Brands (Red Rooster, Oporto), Zip Industries and Officeworks, which were pulled. On face value, the investment arithmetic also appears reasonable, with BIN trading on 15.3x PE in FY18f, with over 30% in EPS growth and net debt/EBITDA of c. 1.0x according to FactSet. Less appealing for some critics is the potential sustainability of this growth, which has fed on Sydney’s building surge, as well as a lack of post-collections assets.

Elsewhere, in late May, JJ Richards and Southern Oil teamed up to open Australia’s first biofuels pilot plant at Gladstone, Queensland. The $18m plant is part of a larg-er project where the duo has committed to investing a further $150m in a commercial-scale biofuel plant. And it wasn’t all quiet from the CWY bunker either, with the company announcing in early June that it had secured the post-collections piece of the Brisbane City Council (BCC) municipal contract, although it missed out on the more significant collections component. Under the BCC agreement, CWY will manage four re-source recovery centres and the Rochedale landfill, which are government owned, for 10 years commencing on 1 July. It is expected to generate revenue of approxi-mately $330m over the life of the contract, with CWY to spend $22m in FY18 to buy the necessary PPE to sup-port its delivery. Based on an EBITDA margin of 13%, this lifts our FY19f EBITDA by c. 1%.

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National Vet Care - A capital idea One of our favourite companies and one of the most success-ful roll-ups from Queensland in recent history has been Na-tional Vets. Its share price has been con-sistently climbing since its full year re-sult in August last year, which reflects management’s suc-cess in delivering both on its acquisi-tions strategy and in terms of organic growth. And during the month the company completed an institu-tional placement of 6.5m shares at $2.25 p/share to raise $14.6m. The offer price reflected a 2.6% discount to the last closing price of $2.31 p/share and a 5.1% discount to the 5 day VWAP of $2.37 p/share. (The Toad had a very small involvement in the raising). The funds from the cap-ital raising will be used to support the company’s acquisi-tion pipeline, augmented when on 14 June, NVL flagged it had acquired one clinic, with a further three under final stages of DD. In total, these four clinics have cumulative-ly generated historical annualised revenue of $8.5m, and are expected to settle between 1 July and 31 August 2017. We have assumed a blended EBIT margin of 22% on these acquisitions, and an acquisition multiple of 5.0x EV/EBIT, implying total acquisition spend of $9.4m. (The company also flagged it will sell an Emergency Centre clinic, which is consistent with its focus on higher margin GP clinic acquisitions, and the Toad’s revised estimates assume the sale completes in 1H18). Along with the capital raising, NVL provided updated earn-ings guidance for FY17, reaffirming revenue growth of 20%+ on FY16, but adjusting EBITDA margin guidance, from ‘in line’ with FY16 pro-forma (18.7%), to between 18.0% -18.4%. Management attributed the lower margin to increased investment in systems and people in 2H17, to support the additional clinic acquisitions announced. Our updated FY17 forecasts imply a 18.2% EBITDA mar-gin, reflecting the mid-point of the guidance range. In ad-dition, on 9 June, the company announced the appoint-ment of (ex Deliotte’s not Argo) Jason Beddow as CFO, to commence on 3 July 2017. We have adjusted our earnings forecasts to reflect the four clinic acquisitions, the ER clinic sale, and the impact of the capital raising. We have also reduced our FY17 EBITDA forecast to reflect the updated EBITDA margin guidance. In total, this has resulted in EBITDA down-grades of 1.6% in FY17, and upgrades of 4.3% and 3.9% in FY18 and FY19 respectively. Post the announced ac-quisitions and including the placement proceeds, we esti-mate NVL has $22m in additional acquisition firepower, excluding OCF. Our acquisition spend forecasts in FY18 and FY19 are unchanged at $7.3m and $7.5m respective-ly. Net debt/EBITDA has fallen from 2.0x pre-raising to a very modest 1.4x at 30 June 2018.

Monday 3 July, 2017 The Cane Toad

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of the Acland operations, as well as the value of New Hope’s port asset in Brisbane, now that coal tonnages through it are likely to abate significantly from 2018, un-less New Hope’s appeal against the Land Court decision is both successful, and dealt with quickly. In other court news, the Toad attended most of Soul’s Federal Court oppression trial in Sydney in late May and early June, when the court was told that “the key reason the cross-shareholding unravelling attempts have been blocked or resisted, is the recognition the current Board, Millner influenced as they are, will lose control”. The court also heard that Tom Millner, currently a director of Soul’s, as well as the son of the current Chairman, wrote of some of those advocating change, that they were “arrogant, publicity seeking, fee grabbing, activists”. But we are yet to learn of the judge’s decision in that trial, so legal sub judice rules influence us to remain silent about some of the more salacious revelations which emerged in evidence, at least at this stage. Turning finally to Soul’s valuation, we note with a mixture of chagrin and gratification that our simultaneous equa-tion calculation approach to value has been reviewed and endorsed by advisors to the companies, at least as far back as 2011, and we attach our updated simultaneous equation workings to this Toad. But we are mindful that a simultaneous equation is not capable of being put to shareholders for a vote, which is why we also attach our working for a nil premium merger of Soul’s and Brick-works, which supports the calculations of our simultane-ous equation methodology, and which is capable of being put to shareholders, and which we trust will soon enough be put to shareholders for a vote. After all this, and in the shadows of the oppression deci-sion of Judge Jayne Jagot of the Federal Court, we note that Soul’s is worth $18.91 p/share, 11.8% above the cur-rent share price of $16.67, while Brickworks is worth $18.19 p/share, 24.2% above the current share price of $13.79. Our nil-premium merger, if implemented, would unlock $670m for existing Brickworks and Soul Patt’s shareholders (see attached). On these bases, both com-panies remain Buy.

So, although the strong share price performance over the past six months has been a “bingo” outcome for CWY shareholders, against a relatively flat market, the Toad still struggles with the hefty valuation, given the relatively low amount of free cash flow the business is forecast to gen-erate. For context, we expect FCF from CWY of around $50m in FY18 and $57m in FY19, which compares with the current market capitalisation of $2.2b. This implies a miserly FCF yield of 2.2% and 2.5% respectively. And while longer-term (i.e. post FY20), CWY’s remediation obligations become less onerous, and therefore FCF should improve (by about $20m p/a), it is still well short of a compelling level. In any case, we value the CWY business by reference to our proprietary DCF model, which takes into account this step-down in spend, and which returns a valuation of $0.81 p/share. At $1.37 p/share, CWY is trading on 30.3x PE in FY17 falling to 25.4x in FY19, and a fully franked yield of 1.5% in FY17 rising to 1.8% in FY19. It remains a Reduce. Soul Patt’s - Business as usual

It’s been business as usual at Soul’s so far this year, with court activity on multiple fronts, and elsewhere, more tink-ering with its share portfolio. Taking this last point first, here is a table of share sales disclosed by SOL since February, which has raised $102m, coincidentally, or oth-erwise, dovetailing neatly with Soul’s obligation to take up $101m new equity in TPG.

Meanwhile, the Toad was as surprised as anyone that Soul’s 60% owned New Hope business failed to secure Queensland Land Court approval for the expansion of its Acland coal mine, west of Toowoomba, in a decision handed down on 31 May. Judge Smith was mightily un-complimentary about aspects of New Hope in his judg-ment, and so a shadow has been cast over the valuation

SOL: Listed equities sales Feb - Jun 2017

Code Company Consideration

MLT Milton Corporation $5,026,516

BKI BKI Investment Company $3,220,000

CLV Clover Corporation $1,466,250

TPE TPI Enterprises $2,913,827

API Australian Pharmaceutical Industries $48,957,227

RHL Ruralco $40,750,190

Total $102,334,010

Source: Company records

Monday 3 July, 2017 The Cane Toad

This report was produced by Hunter Green Institutional Broking Pty Ltd (HGIB), holder of an Australian Financial Services License Number 235259.

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