• FY18 revenue was within expectation
• Negative surprise of a 4Q18 loss dragged FY18 PATMI 25% lower than our estimate
• One quarter of loss during ramp-up is not representative of normalised business
• Overdone sell-down presents an opportunity to purchase mispriced stock
• Upgrade to BUY from Accumulate; new target price of $1.03 (previously $1.30)

The Positives

+ New sludge treatment facility is already treating sludge and expected to be fully operational by December 2018. Recall that the contract awarded by the Public Utilities Board was valued at S$133.65 million for a period of 15.5 years. This implies an average annual additional revenue of $8.6mn going forward.

+ Pasir Ris–Bedok PWC contract has commenced and will start contribution in 1Q19. Recall that the public waste collection (PWC) contract size of $193.5mn awarded by the National Environmental Agency is for a tenure of 7 years and 4 months (average annual additional revenue of $26.4mn going forward). The Pasir Ris–Bedok sector is an amalgamation of the former Pasir Ris–Tampines and Bedok sectors. 800 Super had already taken over the Pasir Ris–Tampines sector since July 2018, and will be taking over the Bedok sector in November 2018.

The Negatives

– Higher than expected manpower costs was the key contributor to earnings miss. Manpower cost is the largest cost component (53% of FY18 opex); and it came in 20% higher than expected for 4Q18 and consequently 4.6% higher than expected for FY18. (Refer to Appendix on Page 3 for further analysis.)

– YoY weaker balance sheet, but it was expected. Debt/equity ratio increased substantially YoY from 64% to 105%. Current ratio has decreased YoY from 1.70x to 0.84x, resulting in a net current liability position. Cash has decreased substantially YoY from S$25.1mn (16% of total assets) to S$5.6mn (3% of total assets). We had already forecasted a YoY weaker balance sheet, this is not a major surprise. (Refer to Appendix on Page 3 for further analysis.)

– YoY lower dividend and lower payout ratio. The lower payout ratio is likely due to capex requirements for the Pasir Ris–Bedok PWC contract that commenced in July 2018 (after the June financial year-end).

Source: Company, PSR

– $446k of goodwill from the acquisition of Iwash Laundry fully written off. The laundry business remains loss-making. However, to put things in context, the goodwill represents only 0.2% of total assets.

Outlook

The outlook is positive. In our recent reports, we had been stating our expectation of near-term PATMI weakness due to transitional ramp-up of new projects. The loss reported in 4Q18 is an aberration and the business has not changed structurally. This one quarter of loss is not reflective of future quarters, nor is it a precursor to deterioration of future earnings.

We are expecting 19%/55% YoY higher revenue/PATMI in FY19e, due to contributions from the sludge treatment facility and Pasir Ris–Bedok PWC contract. However, debt is expected to be higher due to capex on vehicles and bins to fulfil the PWC contract. Correspondingly, manpower cost and disposal charge will increase YoY in FY19e due to these two large projects. Disposal charge is expected to trend higher over the next two quarters, in line with higher throughput at the sludge treatment facility. We expect 800 Super to turn free cash flow positive only in FY20e.

Opportunity: The commencement of the Pasir Ris–Bedok PWC contract puts 800 Super in a dominant position to bid more competitively than the former incumbents Veolia (Pasir Ris–Tampines) and SembWaste (Bedok) for the waste removal contracts with condominiums and commercial properties within the sector. This is a potential source of positive earnings surprise in subsequent periods.

Upgrade to BUY from Accumulate; new target price of $1.03 (previously $1.30)

Our target price gives an implied FY19e forward P/E multiple of 13.0x. As FY19e is transitional, we think that FY20e is a better representation of a normalised full year. We estimate 8.18 cents EPS and 7.84 cents free cash flow per share in FY20e. The current price of 64 cents/share is 8.2x of FY20e free cash flow per share and gives a 3.1% dividend yield (based on our FY20e assumption of 2 cents).

Appendix

Despite the loss in 4Q18, most of the financial numbers did not show material deviation from our expectations. We believe that the market has over-reacted to this non-recurring loss during this transitional period as new projects come online.

Income Statement review

Though we have not shown our 4Q18 estimates previously, they can be inferred from the difference between our FY18 estimate and the 9M18 actual.

• Swing factor of manpower cost was materially higher than we had forecast

Our estimates for 4Q18 expenses were mostly in line, except for manpower cost which was $3.27mn or 20% higher than we expected. This was the largest swing factor between profit and loss in our 4Q18 estimate.

Manpower cost is the largest cost component (53% of opex)

• Headline 43% YoY increase in purchase of supplies and disposal charge in 4Q18 did not come as a surprise

The scale of increase in purchases of supplies and disposal charges in 4Q18 is merely a continuation of what occurred in 3Q18, which was then 28% higher YoY. We had already assumed higher expense for 4Q18.

Supplies and disposal charge is the second largest cost component (19% of opex)

Balance Sheet review

• YoY weakness does not come as a surprise

As indicated by the three financial ratios at the end of Figure 2, we had forecast a weaker balance sheet.

• YoY lower ending cash, as internal resource was used to fund capex

The increase in total debt of $37.1mn was lower than the $66.6mn increase in PPE. The YoY lower cash is a reflection of the use of internal resource to partially fund the capex. Also, debt/equity ratio employed for the additional PPE was 126%, which contributed to the higher gearing.