Tomra – Some Reversal, Some Upside (TMRAY)

Dear readers/followers,

I will go ahead and call myself/name myself a successful investor in Tomra Systems (OTCPK:TMRAY) (OTCPK:TMRAF). For the past year or so, I have been covering the business, initially with a “HOLD” rating only to move to a “BUY” as of fall of 2023 when I myself started purchasing. I increased my pace of purchasing when the company fell to double digits, which has resulted in my Tomra position seeing significant growth, expansion, and profit.

My latest article on TMRAY is one you can find here, and it’s from about 4 months back. The company is up around 20%, which is double the S&P500 since that time, making this a successful overall investment.

As I’ve written before, a positive thesis on Tomra assumes you accept a premium for a business, specifically a business that is a world-leading recycler with the potential for further revenue growth in sensor-based collection and other forms of recycling

I accept some of this premium – though certainly not all of it. But in my last article, I did maintain my “BUY” rating for what, I believe, is the best recycler that’s publically traded and that, as such, can be invested in.

Let’s look here at what we have going for us.

Tomra – Clearer upside following 1Q, but what premium should be applied to the business?

In my last article, I said the following:

My thesis for Tomra is that of a premiumized company moving back to a sort of premium, based on above-average growth rate on a forward basis. Because these latest negatives are based on non-recurring items such as cyberattack costs, I believe the market is severely underestimating Tomra at this, and at lower prices. This forms the core of my current thesis.

I have not markedly or significantly changed from this thesis, and in order to help confirm my stance, I will use the latest quarterly results that the company reported not that long ago. Revenue for that quarter was mostly flat, but not across the group. Collection was up 15%¤, while food and recycling were down 15-16% each.

However, the company maintained its attractive margin structure, with a 40% gross margin level and only a slight increase in overall OpEx YoY, and flat trends on a sequential basis. The company managed a quarterly EBITA of 176, which is down significantly, but there were reasons for that – such as one-offs and special items, as well as cash flow issues – because cash flow was also halved for the quarter.

Order intake and backlog remains indicative of a company with massive demand and interest for its products, however. We’re seeing a backlog of 1.3B NOK in terms of orders, which is up quite a bit, more than 100M NOK for the previous YoY period.

The company’s ambitions for the next 3-4 years remain.

To those unfamiliar, Tomra is looking to essentially create sensor-based sorting solutions for optimal resource productivity. That is the core of the company’s entire business idea – to transform the manner in which we obtain, use, and reuse our resources, in this case, things like food, but also plastics, metal, and the like.

Collection and recycling have long been at the heart of these operations.

It’s also important to mention that over 50% of Tomra’s operations are under extremely attractive regulatory frameworks within the EU. As an example, in late April only 3 weeks ago, the EU Parliament adopted the Packaging and Packaging Waste Regulation (PPWR), a comprehensive legislation adding new obligations across the value chain which add to the current Single-Use Plastics Directive (SUPD) and Packaging and Packaging Waste Directive (PPWD).

Tomra will be a direct beneficiary of such things, and the company is seeking to comply here – though the EU council still needs to formally approve this agreement. However, provisions like these are popping up everywhere, it seems like, and Tomra is a major beneficiary of them.

I also do not think you will find many investors, or people regardless of political conviction, that claims that we can, in terms of waste management, go on doing exactly what we have been doing. This is once again an argument for Tomra.

Food sorting is a tricky business. Tomra has been working here for several years at this point and has had some difficulty closing the gap, as it were. Yes, the order backlog for food is up, but revenues saw a new low in 1Q, mostly due to seasonal effects, but also soft order intake. The overall view I have is that the market isn’t yet convinced by the company’s technology here. Potato-oriented sorting tech is an exception – but other fresh foods and adjacent sub-categories continue to underperform (cherries, apples, and the like). The company even initiated a cost restructuring program which is currently attempting to capture some positives here, and the company showed off new technology at Fruit Logistica Berlin, including an AI-powered system for Blueberries.

The company is in an attractive position for the future – that much is clear to me.

More plastics will need to be recycled, and more recycled plastics will need to be used in new products, with only half of the post-consumer plastic waste being separately collected at this time – but it’s a long process.

The underlying regulatory support for the company’s mission is strong. Regulatory pushes across the globe are happening, and industries are committing to GHG emission reductions, with chemical recycling capacity also increasing, which in turn creates an ongoing demand for recyclates.

The company is also investing once again in two new advanced feedstock sorting plants, one in Germany and one in Germany, with both over 60% (or 100%) owned by Tomra, with investment totaling almost 100M EUR, with a targeted operational IRR of 15-20% over time.

So the company is an active player, and partner, in ongoing processes. The company’s new investments and pushes, overall, are an attractive business model, with a clear pathway to grown and SSP, Steady State Production.

So on that front, things are looking good. Current P&Ls, things are a bit flat. With increasing operating expenses and lower earnings, and a slowing increase in overall revenues, investors may be starting to question whether the premium for the company is actually something that’s justified.

On the fundamental side, I would say worries are very few. The company continues to have very low debt, with a rolling 12-month NIBD/EBITDA of 1.9x, and a 42% equity ratio. Maturities are well-laddered, with a refinancing coming up in 2025, but the company has plenty of funding available at over 400M NOK, and the only relevant financial covenant related to bank debt is maintaining an equity ratio of 30%.

The outlook is mixed, but long-term positive. Short-term, the company is now forecasting slower paces of growth, though it’s also said that the current macro is expected to attract growth potential in recycling and collection.

Food is the problematic area, with macro delaying customer investments – though the company forecasts a medium-term upside here, with a continued need for automation and increased quality and safety.

The company’s savings program is expected to generate its targeted 30M EUR savings by the end of this year – this is actually an easy target for us to follow and make sure that the company manages.

Overall, what I see here are more questions regarding the company’s long-term valuation premiumization – which is why this is what I focus on, the valuation.

Let’s look at what we have here.

Valuation for Tomra

The issue remains insofar as Tomra is incredibly premiumized as a business. The company’s current P/E, despite the decline we’ve seen from 2020-2021, is around 38x P/E for a company that yields less than 1.5% in an environment where the risk-free rate is close to 4% and which neither in 2023 nor is expected in 2024 to provide growth rates that justify such a massive valuation.

What do I mean by this?

As you see above, I mean that the company is not expected to grow more than 4% this year. And when it comes to the double-digit growth rates expected in 2025 and 2026, I want to mention 2 things.

First, the estimates for these years less than 6 months ago were twice as high as they are now, but have been cut, and secondly, analysts have a negative failure forecast accuracy of 42% (Paywalled FAST Graphs Link), meaning that 42% of the time, the company does not hit analyst estimates, but misses them with more than 20%.

So despite operations that might seem very stable, the company’s high valuation has made sure that there’s quite a bit of valuational volatility to the stock – that is also completely understandable when you see how likely or unlikely the company has been to hit targets.

So, why am I positive about the stock? Because that’s what I am. In the last article, I did make a 150 PT – and while I am cutting this to 145 NOK at this time to reflect a slight downgrade in growth assumptions, that still makes the company a “BUY” at this time.

It really has to do with the long-term potential of this company. While the timing and materialization of earnings upsides to this company is uncertain, I view their eventual upside as an inevitability here. It will happen, as I see it, and Tomra will continue to grow. The company has put itself in a position to be a market leader for recycling and collection as well as fresh foodstuff sorting, not just in Europe but elsewhere as well. In many ways, it enters fields that other companies like the German GEA Group also represent, if only a portion of their overall upside.

As I made clear in my last article, the way I go about this is to discount this down to a normalized P/E of 30x. Any higher than 30x, it is extremely unlikely that you will find me investing in any company. That sort of valuation typically, to me, makes no sense at all. S&P Global analysts following Tomra as a business do not consider it worth anything close to my own PT – but these are the same analysts that only a year ago most of them were over 180-200 NOK/share. They are no longer at a massive low, but they also haven’t “upped” the company back to levels I would consider relevant here. When I last wrote about this, we had a low of around 80 – that’s now up to 95 NOK, with a high of 130 and an average of around 117 NOK. (Paywalled TIKR.com Link)

I maintain that these analysts are still slightly underestimating where the company over time will be – and this is the reason why I, on the basis of estimates here, give the company a rating of “BUY” and a PT of 145 NOK/share.

My thesis on Tomra is as follows.

Thesis

• Tomra is a market-leading, world-leading reverse vending machine and recycling business. At the right price, it becomes a “MUST-BUY”, with a holding target that goes beyond the usual, for a superb business model with proven reach and scalability.
• However, anything above 45x P/E is a no-go for this business, and I want it cheaper. I don’t believe sub-25x P/E is in the possibilities, but 25-35x is the most I will pay.
• This comes to a PT of around 145 NOK conservatively, and this makes the company a “BUY” here. I continue to view it as a “BUY” in May 2024.

Remember, I’m all about:

• Buying undervalued – even if that undervaluation is slight and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
• If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
• If the company doesn’t go into overvaluation but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
• I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them (italicized).

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside that is high enough, based on earnings growth or multiple expansion/reversion.’

It’s not cheap, but I’m willing to call it a “BUY” here based on an attractive enough price target for the company.

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