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 MARKET REPORTS |
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Analyst report - shares
"Stock of the week": Envirozel Limited
October 8, 2007
Tim Morris, wise-owl.com analyst
Stock: Envirozel Limited
Code: EVZ 
As the baby boomer generation transitions into retirement, many small businesses are faced with the issue of succession planning. Envirozel (EVZ) has built up its business by providing the owners of small industrial businesses an exit strategy as they look to retire, or alternatively, access to greater financial resources, if they’re looking to expand their business.
Envirozel is an 18 year old company that was restructured three years ago, with the appointment of a new board and the adoption of a fresh business model. This model involves the acquisition of well established, cash flow positive businesses from private owners with strong organic growth potential. In addition to operational synergies and economies of scale, this model creates wealth because businesses that are part of a publicly listed company attract greater value from investors than privately owned entities. Therefore, the multiple placed on these businesses under the Envirozel umbrella is much greater than the multiple Envirozel actually bought the business for.
The businesses currently owned by Envirozel operate in the infrastructure, water and engineering industries. They include NuSource Water, Syfon Systems, Brockman Engineering, and the recently acquired Danum Engineering, National Engineering, and TSF Engineering.
NuSource provides water harvesting and treatment systems with ecologically sustainable developments. Syfon Systems is a specialist division focusing on†environmentally friendly roof drainage technology such as reticulating storm water from rooves. After only one year of new management laying the groundwork, these two businesses provided Envirozel with its maiden profit during 2005-06 financial year.
Subsequent earnings momentum has been built up over the most recent financial year after Brockman Engineering was added to the Envirozel stables in April 2006. Brockman designs and fabricates large scale tanks, silos and cooling towers for the chemical, petroleum, agriculture and water industries.
With Brockman’s contribution, total revenues for 2006-07 increased by 249% $48.3m, and net profit rose 284% to $5.9m. Earnings Per Share (EPS) was also strong, rising 165% to 3.55c. The rate of increase was lower than other performance metrics because of the dilution from additional share issues during the year, which were used to fund acquisitions. Cash at years end was $8.2m, well up on the $1.7m balance seen last year. Importantly, the increased cash flows have been driven by the underlying operations of the company, the cash flow from which increased more than 3000% to $7.1m.
During this period, Envirozel purchased two engineering companies, ‘Danum’ and ‘National’. Danum Engineering was acquired in late 2006, and provides construction, installation and maintenance engineering services. For the 6 months to June 30, the business generated revenues of $17.6m. National Engineering was acquired in May this year, and details, fabricates and erects structural steelwork for the construction and mining sectors. In the one month to June 30, the business generated revenues of $958,480.
This spending spree has seen debt levels rise and total debt to equity stands at a dizzy 110%. However most of this debt is in the form of short term trade payables, and when excluded, long term debt to equity stands at a modest rate of 27%. Undoubtedly a significant amount of cash flows will be directed to paying down the $17m of payables due in the coming year, however the boost to earnings from recent acquisitions should more than compensate.
Envirozel’s most recent acquisition was TSF Engineering, which specialises in the design and installation of power generation and communications equipment, as well as marine installations. TSF operates across Australia and the Asia Pacific, and generated revenues of $33m in the last financial year, with the average profit figure being $5.5m over the last two years.
The $14m purchase price, being less than three times profit and half last years revenue, seems attractive, and together with the National Engineering acquisition, the deals have the potential to double Envirozel’s revenues and net profit in the coming year. A further boost to earnings should come via a full year’s contribution from Danum Engineering, synergies from the consolidation of older businesses, and possibly, new acquisitions.
The performances of all businesses acquired thus far have improved under Envirozel’s public company structure. As all of the former private owners are still involved in their respective businesses, the improvement is a reflection of the power that Envirozel’s resources can provide, which is an important tool for attracting future acquisitions and maintaining earnings momentum.
At current prices over 55c, the stock is trading on a PE of just over 15, which is reasonable considering its growth prospects. Strong organic potential lies in existing businesses given their exposure to the water management, infrastructure and engineering industries. The potential for further acquisitions is a bonus.
In recent trading the stock seems to have broken from a four month long consolidation phase which saw it range between 50-55c. Should momentum persist, the stock could re-test its previous highs of 69c in May. However if the rally fails, the 50c mark provides a nice support level, which from a technical perspective, potentially limits the downside risk.
Speaking of risks, the main one facing Envirozel is their ability to integrate newly acquired businesses under the Envirozel umbrella. A general economic slowdown would be bad news, but it is a risk associated with most companies. Envirozel’s high level of short term liabilities and the extent to which they eat into this year’s cash flows is also worth monitoring. However, overall we feel that the potential upside in the stock far outweighs these risks.
Tim Morris is an analyst at wise-owl.com, one of Australia's leading independent stockmarket research houses. Click here for your complimentary report.
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Please note that CompareShares.com.au simply publishes analyst reports on this page. The publication of these reports does not in any way constitute a recommendation on the part of CompareShares.com.au. You should seek professional advice before making any investment decisions.
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