Tomra Systems Stock: Opportunity To Buy A Quality ESG Franchise

Woman at the reverse vending machine recycle plastic bottles, ecology concept

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Investment thesis

The recent drawdown in Tomra Systems (OTCPK:TMRAY) is an opportunity to buy the shares. The company remains a standout investment in the ESG space and deserves to trade at a premium valuation with its sustainable growth outlook. The shares are trading on consensus free cash flow yield of 1.9% for FY12/2022, and we believe the market is pricing in the prospects of stable long-term earnings growth.

Quick primer

Tomra Systems is the world’s pioneer in recycling plastic bottles with its reverse vending machines. It also provides sorting and recycling machines for mining and waste management sectors, and sorting machines for the wholesale food sector for fresh fruits (e.g. blueberry, cherry, and kiwi) and processed food (Tomra has 80% global share in French fries sorting machines). Core geographic markets are Europe (Scandinavia and Germany) and North America.

Key financials with consensus forecasts

Tomra Systems Key financials

Key financials (Company, Refinitiv)

FY12/2021 sales split by segment

Tomra Systems FY12/2021 sales split by segment

FY12/2021 sales split by segment (Company)

FY12/2021 EBIT split by segment

Tomra Systems FY12/2021 EBIT split by segment

FY12/2021 EBIT split by segment (Company)

EBIT margins by segment – FY12/2021 versus FY12/2020

Tomra Systems EBIT margins by segment - FY12/2021 versus FY12/2020

EBIT margins by segment – FY12/2021 versus FY12/2020 (Company)

Our objectives

After a solid showing in FY12/2021 Tomra’s shares have fallen 28% since the peak in December 2021. Management appears to be cautious regarding short-term trading conditions given supply chain challenges, inflationary cost pressures, and difficulties ascertaining the timing of new collection projects. In this piece we want to assess the following:

  • the demand profile for each business segment.
  • any implications over the recent changes in both CEO and CFO positions in the last 12 months.

We will take each one in turn.

Stable earnings visibility

The bright spot for Tomra’s order book is in the Recycling Mining business (page 5), driven by high commodity prices. This segment is a short-cycle business meaning that the demand profile can change relatively quickly; if commodity pricing comes off, current levels of demand will be hard to sustain. For the time being, the outlook here is positive and Tomra can maximize profit growth in their highest return business segment.

Growth prospects in the Collection business (the PET and glass bottle collection systems) are primarily reliant on new markets implementing a deposit return policy and infrastructure. We believe in the necessity for recycling as a secular growth theme, but believe that the ‘early adopter’ markets are in place and it will be harder to convert fresh markets. Consequently, FY12/2021 sales grew 9% YoY (page 4) under constant currencies – a steady growth profile for a recurring revenue stream. We expect a similar situation into FY12/2022, although there is a risk of a slowdown YoY with higher hurdles and no major market expected to come online.

The weakest area of the business is the Food segment in terms of profitability and outlook. Despite its defensive nature associated with consumer staples, sales have remained flat YoY in FY12/2021 (page 6) as the food services industry continues to experience a mixed recovery. Lead times remain long as a result of supply chain issues, and the order intake volumes did not demonstrate significant improvement post-pandemic.

Overall, we believe the outlook for demand will result in stable topline growth for the medium to long term, as opposed to a major growth acceleration scenario.

Next, we look at the sudden changes in senior management.

A time of generational change

Current CEO Tove Andersen was appointed in April 2021, replacing Stefan Ranstrand who has been in this post since 2001. In March 2022 Eva Sagemo was appointed CFO, replacing Espen Gundersen who was appointed in 2002. These major changes in senior management have come in quick succession.

Getting new talent to head the business may introduce a renewed sense of growth and purpose at Tomra. Conversely, it may be of some concern that two leadership members have departed within a year of each other. However, both departees have enjoyed a successful two-decade stint and should be congratulated for their achievements.

Andersen comes from fertilizer company Yara International (OTCPK:YARIY), bringing in-depth knowledge of agriculture and food production. CFO Sagemo is an internal hire, having joined Tomra in 2012 in finance and audit. We do not have much color over how they will re-shape the business and its strategy. However, with the company in a strong market position and the secular growth drivers unchanged, the outlook for the business remains positive.

Balance sheet

The company remains well-capitalized with a debt to equity ratio of 0.3x in FY12/2021. The equity ratio is high at 51.8%, comfortably higher than its bank debt covenant level of 30%. Liquidity is sufficient with a current ratio of 1.5x.

Valuations

On consensus forecasts (please see Key financials table at top of article), the shares are trading on PER FY12/2022 53.8x and a free cash flow yield of 1.9%. These are not discount valuations, but we believe the market is pricing in the prospects of stable long-term earnings growth as Tomra continues its journey to penetrate new markets for its recycling and collection activities.

Risks

Upside risk comes from legislation, particularly in Europe, for its Collection business. The UK is beginning to assess a reverse vending machine format, and other countries are likely to follow this trend as consumer opinion drives policy development.

Asia remains an untapped market for Tomra. Whilst barriers to entry appear high with different regulations and consumer behavior, any breakthroughs here would be a positive development.

Downside risk comes from a notable deceleration in sales growth. This could be due to demand weakness or a lumpy sales profile as the lead times for negotiations lengthen or the implementation of new markets for collection services experience delays.

There is downside risk from a strengthening Norwegian Krona. A 10% move against other currencies would decrease operating profits by 10% to 15%. Conversely, a weakening Norwegian Krona would be beneficial.

Conclusion

Tomra remains a standout investment opportunity in the ESG theme and the circular economy. As a market leader, we believe the shares deserve to trade at a premium. The recent changes in senior management appear to be for benign reasons, although there is limited disclosure on any potential changes to business strategy. There is a Capital Markets Day planned for 23 June 2022 which may highlight new management initiatives.

The recent drawdown in the share price provides an opportunity to buy the shares. On a long-term timeframe, we believe Tomra will continue to generate growth at high single-digits YoY whilst consolidating its market position. As a free cash flow generating business with a sustainable growth trajectory, we remain buyers of the shares.

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