How to find an ASX "super stock" early (and an example of one)

A few weeks ago, we did a search for “Aussie Super Stocks” by filtering for listed Australian companies (ex resources) that had generated a Total Shareholder Return of >20% per annum over the last decade. See below.

It was a nice surprise to see our largest holding, The Environmental Group (ASX: EGL), pop up in 10th position, surpassing some well-known compounders like NextDC (ASX: NXT), Objective Corp (ASX: OCL) and Supply Network (ASX: SNL).

What’s unique about EGL is that almost all that outperformance began in the last four years, when the current management team took over in 2020/21.

Since 2021, EGL has compounded revenue, EBITDA and cash EPS at 28%, 50% and 44%, respectively. This goes a long way to explaining why it’s in the Top 10 for Aussie Super Stocks.

Based on the FY24 result, and the bullish outlook, this compounding doesn’t seem like it’s going to stop anytime soon.

We last wrote about EGL in March of this year. The full-year result beat our expectations, as did the FY25 guidance, so we thought a brief update was warranted.

FY24 Result – Another Beat and Upgrade

The full-year results for FY24 continued the trend. The result was significantly ahead of guidance (+51% vs guidance for +45%), with early guidance for FY25 of EBITDA growth of +25%.

EGL now has a track record of beating and upgrading earnings guidance. Since we joined the register three years ago, EGL has had to upgrade existing earnings guidance five times.

For FY25, it is our view that there is room for this number to be upgraded as the year progresses, based on growth primarily in Baltec, EGL Energy and EGL Waste.

We provide our earnings estimates below for FY25 and FY26, along with the respective valuation metrics. Note that we always value companies on a cash-earnings basis.

The above has EGL trading on a PE (ex-net cash) of 13x in FY25, and 11x in FY26. For a business with the track record EGL has now built, with organic earnings growth in FY25 set for +25%, that looks attractive.

Zooming Out

Previous wires on EGL have gone into greater detail, but sometimes it is worth zooming out.

When we first acquired our position in EGL the company traded on 8-10x EV/EBITDA. Today, based on FY25 guidance, the stock trades on 9x forward EV/EBITDA.

That is, despite the significant increase in the share price, EGL’s appreciation has been entirely driven by earnings growth, with no multiple expansion. We think the latter is still coming.

It’s worth considering why EGL has been such a strong performer to date. The characteristics of the business we like are the following:

- Exposed to several attractive thematics: tailwinds from a growing market can solve a lot of problems. EGL is exposed to several multi-year thematics (ESG, electrification, transition to renewables, regulations on waste management, pollution control).

- Diversity of revenue: Within EGL are several businesses each exposed to different industries. While all are growing over the long term, there are cycles within each, and the diversity of revenue across each business has served to smooth these out. e.g. EGL Clean Air in FY24 was flat due to the collapsing lithium price dampening CAPEX budgets, but this was more than offset by growth in the rest of the business.

- Recurring revenue streams: Our favourite businesses generate the majority of their earnings from revenue that is locked in at the start of each year. EGL must now be close to generating 80% of earnings from recurring sources like servicing, maintenance and parts.

- Competitive Advantages: The market still underappreciates the competitive advantages of EGL’s technology or market position in each respective business. Baltec is a leading provider of gas turbine technologies, particularly in silencers. There are only two or three providers in the world that can provide the type of industrial-grade air pollution control systems that EGL Clean Air can provide. EGL Energy is the largest service network of its kind in Australia with a 35% market share and the only provider with 24/7 national network coverage.

- Capital light: EGL’s CAPEX budget each year is minimal. This is a capital-light business with high returns on incremental capital. It is also why ‘EBITDA’ is an appropriate measure of business performance, though we like to use cash EBIT as our preferred metric.

- Aligned management: Jason Dixon, CEO of EGL, owns >5% of the company and along with his team has executed the business plan with precision to date. Over time, the market tends to pay a premium for management teams they can trust.

Ironically, these days the factors that often lead to the greatest multiple expansion aren’t entirely tied to business performance at all but relate to market cap, the share register, liquidity and index inclusion.

EGL’s market cap only recently surpassed $100 million. The register has changed hands in recent months to now include several well-known institutions. Liquidity has gotten better, though still needs to improve.

In FY25, if EGL hits guidance, they will generate cash EBIT north of $10 million with >25% organic earnings growth. We suspect this will look attractive to investors at a time when growth in general is hard to come by.

We have had to trim our position over time as it became an excessively large holding, but we continue to hold EGL as the largest investment in the Inception Fund and see no reason to interrupt the compounding.

Over the last 12 months, we’ve built new core positions in undervalued small-cap companies and look forward to sharing some of them in the coming weeks and months.