| Q415 Results – Tanks & Industrial Division Continue to Drag Results Down; Management Tone Suggests Better Days Ahead · The bottom line: STT Enviro Corp. (“STT” or “the Company”) reported Q415 results on Monday with a conference call yesterday. We were cautious walking into the quarter in light of challenging end-market conditions and recent cost overruns ( preview note - March 8, 2016). The results came in below our cautious expectations, but conference call commentary and our discussion with management suggest that the Company is turning the corner vis-a-vis cost overruns. H115 sales will be challenged with delays in the awarding of new projects, but we expect the Company to execute on margins. The Company continues to maintain a substantial cash position ($5.9M, or $0.133/shr – equating to 66.5% of current market capitalization), providing for exceptional defensive characteristics. We are maintaining our Speculative Buy rating and $0.40/shr price target. · Cost overruns in Tanks & Industrial division swing Q415 EBITDA to negative territory: STT reported Q415 Sales/EBITDA of $5.9M/-$1.1M versus our estimates of $6.3M/$0.3M. Sales were down 7% for the quarter compared to our estimate of flat y/y growth from what we considered solid Q415 results. The Company closed out the year with $33.8M/$1.1M in Sales/EBITDA, representing y/y growth of +51%/-52%. · We went into the quarter expecting some potential downside risk to our margin forecasts on the back of a challenging Q315, which saw EBITDA margin compress to 3.0% from 10.0% the previous year. We noted that the Company had only recently hired a new group head for the division (February 2016) and we thus felt that by any measure cost control initiatives had not yet been implemented. EBITDA swung to negative territory on continued cost overruns in the Tanks & Industrial division. The Company’s consolidated GM came in at 2.3% during Q415 (versus 22.3% in the previous 3 quarters), with the Systems & Solutions group delivering a solid 44.1% GM and the Tanks & Industrial division underperforming at -28.1% GM. The Company made catch-up adjustments during Q415 to the Tanks & Industrial division margins recorded in previous periods, resulting in overstatedly depressed Q415 margins. · No new project announcements lead to continued backlog weakness, reflecting challenging end-market conditions – management comments on the conference call suggests increased customer engagement as of late: We note the Company’s closing backlog as at Q415 of $19.8M (-30% y/y and -10% sequentially). The Company continues to bid on projects and the management team commented that the “sales funnel remains quite full” but noted that “customers originally expected to award the work during the fourth quarter, but these awards have been delayed, likely to mid2016.” The Company’s tone on the conference call suggested that there is increased customer engagement as of late, which should alleviate investors concerns. While we anticipate a slower first half of the year, we expect to hear of new project announcements that would act as a catalyst to the stock price. · Balance sheet remains in solid condition, providing for exceptional defensive characteristics: STT is debt free, having concluded an aggressive debt repayment plan in Q215, which saw its long-term debt position decline from $2.8M in 2014 to virtually nil. STT ended the year with $5.9M in cash or $0.133/shr – equating to 66.5% of current market capitalization. · Estimate revisions and valuation: We are now calling for 2016/2017 Sales of $31.1M/$37.4M and 2016/2017 EBITDA of $1.7M/$4.0M. This compares to our previous estimates of $37.4M/$42.8M and $2.7M/$3.6M, respectively. Our longer-term forecasts are intact. The changes have negligible impact on our valuation. · We derive our $0.40 target price using a discounted cash flow analysis with a 15.0% discount rate and a 2.7x exit EBITDA multiple. Investment thesis: STT exposes investors to a solid and growing business at what we believe to be very compelling valuation levels. With the Company currently trading at what we consider deep value levels (2.2x EV/2016E EBITDA), we see this as an opportunity to consolidate a position in a quality operation. Despite the mining and oil & gas downcycle, we see organic top line growth of 7% per annum over the next three years, driving EBITDA growth of 65% per annum during the same time period. An upswing in the mining and oil & gas sectors could see STT materially outperform our forecasts. While we recognize the risks of customer concentration and industry cyclicality, we believe the Company presents attractive risk-reward characteristics at current levels. We are namely comforted by STT’s net cash balance of $0.13/shr, providing limited downside from current levels relative to our targeted return. |