Company Overview: HRL Holdings Limited (ASX: HRL) is in the business of environmental services, hazardous material, waste management and ongoing compliance solutions utilizing technological platforms. The group offers services including analytical chemistry laboratory testing, industrial hygiene, geotechnical testing and engineering services, environmental and property management software solutions etc. Its segments are OCTIEF branded operations and Precise Consulting branded operations. It also offers various specialized environmental services through OCTIEF Pty Ltd and Precise Consulting and Laboratory Limited.
HRL Details
Improvement across All Key Metrics: HRL Holdings Limited (ASX: HRL) is in the business of environmental services, hazardous material, waste management and ongoing compliance solutions utilizing technological platforms. The group offers services including analytical chemistry laboratory testing, industrial hygiene, geotechnical testing and engineering services, environmental and property management software solutions etc. As on 31 July 2020, the market capitalization of the company stood at ~$54.27 million. HRL returned decent performance for the first nine months of FY2020, ahead of internal budgets. However, the fourth quarter was heavily impacted by the effects of COVID-19. Despite this disruption, the overall financial performance of the group witnessed an improvement on FY2019 across all key metrics.
During the year, revenue of the company went up by 7% to $32.8 million and reported an increase of 24% in underlying EBITDA to $6.9 million. In the same time span, NPAT of the company witnessed a significant increase of 61% in NPAT to $2.4 million, up from $1.53 million in the pcp. This was mainly due to higher earnings from Analytica and HAZMAT division and decreased corporate overhead costs. During the year, the group generated operating cash flows of $6.31 million and has undrawn bank facilities of $4.25 million, comfortably met all banking covenants during the period. In the same time span, the company reported Debt to EBITDA of 66% with net debt of $1.1 million.
During FY20, the company increased its organic service development with a focus on scalable laboratory-based services and integrated the business units HR, IT, finance, and support services. This resulted in increased earnings from the data management and software division. The company has also secured new laboratory facilities for HRL’s main Hamilton NZ operation to facilitate long term growth and improve workflow efficiencies. The company has also supported JV investments and partners to realize their strategic potential.
It is focused on a return to FY2018 levels of profitability by continuing to replace the earnings gap from the decline in demand for property contamination testing. The company has improved its social responsibility focus with no reportable injuries in the second half. The group is also evaluating acquisition opportunities for high-quality testing, inspection, and certification businesses.
FY20 Financial Highlights (Source: Company Reports)
Details of Top 10 Shareholders: The following table provides an overview of the top 10 shareholders of HRL Holdings Limited. Viburnum Funds Pty Ltd. is the largest shareholder in the company, with a percentage holding of 24.11%.
Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)
Well Management of Costs and Stable Balance Sheet: During 1H20, gross margin of the company stood at 85.4% as compared to the industry median of 30.6%. In the same time span, net margin saw a slight improvement over the past year. Higher gross margin and improvement in net margin indicates that the company is well managing its costs and is capable of converting its revenue into profits. During the half-year, EBITDA margin of the company was 1.8%. In the same time span, ROE witnessed an improvement in the past year and indicates that the company is well managing the capital of its shareholders and can generate profits internally. During 1H20, Assets/Equity Ratio of the company stood at 1.4x, lower than the industry median of 2.37x and Debt/Equity Ratio was 0.24x as compared to the industry median of 0.4x. This indicates that the business is financed with a more significant proportion of investor funding and a small amount of debt, resulting in a financially stable balance sheet.
Key Margins (Source: Refinitiv, Thomson Reuters)
Divisional Performance: The HRL Group was impacted primarily through the lockdowns put in place throughout New Zealand, and Analytica was only allowed to operate its food and water testing service lines. On the other hand, OCTIEF performed well during Q4 with most of its workload being from government departments and utility providers. The other division of the company, Morrison Geotechnic, which is directly exposed to the residential development sector, witnessed a decline in revenues in Q4.
Despite the impact of COVID-19, Analytica continues to perform well with an increase of 14% in revenues as compared with the prior period, highlighted by an increase in honey revenue, strong milk testing and growth in food origin testing. Environmental testing services which included laboratory testing of air, water and soil continued its development with decent growth in revenues but was shut down during Level 4 lockdowns. Despite this setback, revenues grew 34% on the prior year. The Software division incorporates the OCTFOLIO business unit, which saw rapid growth trajectory highlighted with the securing of a five year, $1.5 million contract with a key government agency.
Segment Performance (Source: Company Reports)
Key Risks: The group is exposed to a variety of risks, including credit risk and foreign exchange risk. However, the company does not have any material credit risk exposure to any single counterparty, except for its holdings of cash which is held with the Westpac Bank and National Australia Bank. The company may also encounter difficulties in raising funds to meet financial obligations. The stock is also thinly traded, which might pose difficulties for the investors to exit the market.
Future Expectations and Growth Opportunities: HRL has built a decent balance sheet with net debt of $1.1 million. The company has completed Analytica vendor earnout, allowing for free cash flow to be used to accelerate organic growth. The outlook for FY21 is mixed across the service lines. Food testing services such as honey and dairy held up well during the lockdowns with little change in sample volumes. These markets will be more influenced by the underlying production seasons and the overall demand for products, especially from international markets.
The outlook for FY21 is cautiously optimistic. Precise has positioned itself as the leading asbestos consulting firm in New Zealand, which gives it a solid presence in tendered opportunities. HRL also retains a positive outlook for OCTFOLIO business unit, with the software platform being upgraded to target a broader range of industries and smaller commercial operators. However, project tender opportunities are down on historical levels with increased competition amongst geotechnical firms. The company is more focused on NZ opportunities and is progressing well through laboratory accreditations and customer development. The food testing levels are likely to be driven by usual primary production factors. The company has a focus on cost control and working capital management and will continue to evaluate acquisition opportunities for high-quality testing, inspection, and certification businesses.
Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)
Valuation Methodology: Price to Cash Flow Multiple Based Relative Valuation (Illustrative)
Price to Cash Flow Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)
Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months
Stock Recommendation: During FY20, the company reported decent margin performance and is achieving progress on the execution of its Strategic Plan. Australian businesses continued to trade without interruption during April and May and hence has shown resilience in the times of uncertainty. As per ASX, the stock of HRL gave a return of 15.79% in the past three months and a return of 4.76% in the last one month. The stock is also inclined towards its 52-weeks’ low level, proffering a decent opportunity for accumulation. We have valued the stock using the price to cash flow multiple based illustrative relative valuation and have arrived at a target price offering an upside of lower double-digit (in percentage terms). Considering the current trading levels, decent returns in the past three months, improvement in margins, resilience in performance despite the global pandemic and positive long term outlook, we recommend a ‘Speculative Buy’ rating on the stock at the current market price of $0.11 on 31 July 2020.
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HRL Daily Technical Chart (Source: Refinitiv, Thomson Reuters)
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