Australian mining investment is projected to jump by 50 per cent this year as strong commodity prices encourages mining companies to push ahead with as many projects as they can handle. Mining services companies are set to benefit with full order books and an ongoing pipeline of work.
To investors this represents a golden opportunity to ride the current boom by choosing the best of the companies within a sector that has consistently outperformed the market. Comprising around 5 per cent of ASX-listed companies by market cap, the number of companies offering mining services in exploration, construction and production inputs to miners has more than doubled since 2008.
Based on Lincoln Indicators data this sector has an enviable weighted average ROE by market cap of 20.75 per cent. Investment in domestic energy and mining sectors surged by 21 percent over the previous six months to 31 December 2010, to $132 billion. With mining on the cusp of an even greater upturn in capital expenditure investment, the outlook for the mining services sector at large looks particularly rosy.
Around $10 billion is expected to be spent on expanding iron ore capacity in WA alone. Mining services companies heavily exposed to WA’s mining bonanza also successfully avoided the ‘net-negative’ impact of Qld flooding on mine sites in effected areas. The state’s booming iron ore industry is directly responsible for strong returns of mining services and processing company Mineral Resources (MIN), and its significantly smaller counterpart Maca (MLD) which both reported a 121 percent jump in net profit.
Graeme Carson senior industrial analyst with Wilson HTM expects ‘approved’ projects for contracting companies to start flowing through to earnings either by the current June half or into financial year 2012.
The mining services sector also offers investors strong exposure to the mining boom without being overly leveraged to ‘toppy’ commodity prices, which will eventually fall from their cyclical highs. And unlike mining stocks, most mining services companies pay franked dividends.
Conservative investors may be attracted to the diversified order books of the dozen mining service firms - like Campbell Bros (CPB), Mineral Resources (MIN), Bradken (BKN), and Monadelphous Group (MND) - valued at over $1 billion. Many of these large caps are leveraged to both mining and oil & gas. But due to ongoing delays to very large projects, Trent Barnett head of Research with Hartleys expects their smaller counterparts - often with market caps under $100 million - to benefit from smaller projects coming to market first.
Many of these stocks are expected to double their revenue within five years. But with price to earnings (P/E) valuations creeping back up towards their pre-GFC levels at 16x, Barnett says investors need to carefully select companies that will win their fair share of orders necessary to deliver sufficient growth upside. “Mining service companies displaying sufficient opportunity for growth are those directly exposed to mid-tier gold and based metals mines where the margins are more favourable,” says Barnett.
Rather than being too fixated on this massive pipeline of projects, Roger Leaning head of research with RBS Morgans says investors should consider buying their favoured stocks before contracts are awarded. He says those who sell after awards are announced could look to lock-in any share price upside before the risk of ‘contract execution’ finds its way to the price.
Given the protracted approvals process confronting large projects, Leaning suggests investors look to mining services companies leveraged to early-stage work, like Campbell Bros (CPB), Boart Longyear (BLY), Carnedo (CDD), and Runge (RUL). Despite looking fairly valued, he says good operational leverage and opportunity for margin expansion should see these and other stocks re-rated - especially once contracts finally drop and earnings are upgraded.
Graeme Carson, Senior Industrial Analyst, Patersons
1) Ausdrill Ltd (ASL):
Chart: Share price over the year to 27/02/2011 versus ASX200 (XJO)
Expected to report a solid interim earnings result later this month following renegotiation of some key contracts previously operated by Brandrill as well as an earlier recommencement of exploration drilling operations in the New Year due to high demand. The company is well and truly emerging as a dominant force in Australian and African contract mining services and the growth outlook is underpinned by the gold and iron ore-dominated order book. Trading at a 15 percent discount to the $3.89 target. ROE 12.9 percent.
2) Bradken Ltd (BKN):
Chart: Share price over the year to 27/02/2011 versus ASX200 (XJO)
Following a first half net profit increase of 1.1 percent the mining equipment company is expected to grow by 15 to 20 percent over last financial year on the back of the group’s US Engineering division and domestic mining products business. Paterson’s positively rates BKN’s sound business, strong market positions and proven management. Trades at around a 20 percent discount to Paterson’s $9.85 target, ROE 23.9 percent.
3) LogiCamms Ltd (LCM):
Chart: Share price over the year to 27/02/2011 versus ASX200 (XJO)
This specialised engineering services group is one of Paterson’s top small cap industrial picks with forecast average annual EPS growth of c30 percent to full year 2013, driven by a clear strategy being well executed by an impressive management team. The result shouldn’t have a material share price impact in either direction, but Paterson’s says LCM should be bought for portfolios with a medium to long term view. Trading at around a 20 percent discount to Paterson’s $1.89 target, ROE 12.09 percent.
4) Maca Ltd (MLD):
Chart: Share price over the year to 27/02/2011 versus ASX200 (XJO)
Following a highly successful IPO in November, management recently upgraded its earnings guidance for the 2011 year. Growing demand for contract mining services sees MLD well-placed to secure additional work in the short-term with already high visibility over prospectus revenue forecasts. The balance sheet is in a strong position to fund equipment purchases following the $35 million capital raising and MLD has demonstrated a track record of return on assets above the average of its peer group (at c20 percent). Near term share price catalysts include interim results and contract wins. Trades on an 11 percent discount to Paterson’s $2.98 target. ORE 39.31 percent.
5) Orica Ltd (ORI):
Chart: Share price over the year to 27/02/2011 versus ASX200 (XJO)
Although Paterson’s expect the Qld floods to have a modest impact on FY2011 earnings, it believes ORI remains on track to deliver NPAT growth on a comparable basis. To this end, they positively rate the group’s leading market position, geographic and commodity diversity and strong management. Trades at a 10 discount to Paterson’s $28.90 target, ROE 26.6 percent.
Trent Barnett, CFA, Head of Research, Hartleys Limited
1) Imdex Ltd (IMD):
Chart: Share price over the year to 27/02/2011 versus ASX200 (XJO)
Barnett has increased his price target to $2.49 from $2.08 based on an assumption IMD will trade at a P/E premium to other small cap mining service companies. He believes this is possible given: The rental model allows for high margins and high revenue predictability, competition is low given the high R&D barrier to entry, its predominance as a global market leader in mineral downhole survey tools and drilling mud - especially given its large economy of scale, and the likelihood of the market capitalising R&D spending towards the top of the cycle. Trading at $1.85.
2) MACA Ltd (MLD):
Chart: Share price over the year to 27/02/2011 versus ASX200 (XJO)
Barnett’s increased valuation to $3.01 from $2.96 assumes that MLD can grow to ~$500 million of revenue by full year 2014 but thereafter no growth. To reach his targeted revenue, he estimates ~$130 million in capex, implying an average of ~$0.70 cents of capex per dollar of increased revenue ~14 percent return on assets. His increased twelve month price target to $3.35 from $3.30 implies MLD trades on 11.2x full year 2013 P/E and 7.7x EV/EBIT, assuming full year 2013 revenue of ~$450 million. Currently, the stock is on a full year 2012 P/E of 12.2x and full year 2012 EV/EBIT of 7.8x. Currently trades at $2.63.
3) Pacific Energy (PEA):
Chart: Share price over the year to 27/02/2011 versus ASX200 (XJO)
Owner and maintainer of remote mine power stations, PEA’s baseline revenue is supported by long-term contracts with strong growth from the WA mining cycle. Barnett has increased his valuation by reducing previous capex assumptions surrounding long delays between capex outlays and earning revenue, and has subsequently increased his DCF valuations accordingly. On his estimates, PEA trades at full year 2012 P/E of 11.5x and EV/EBITDA 6.0x – which looks attractive given the high margin and contract nature of the business. Currently trading at 25 percent discount to Barnett’s $0.57 twelve month price target.
4) NRW Holdings (NWH):
Chart: Share price over the year to 27/02/2011 versus ASX200 (XJO)
The current full year 2011 order book for this WA-based civil and mining contractor is $643 million and $226 million for full year 2012. So to reach Barnett’s revenue targets, NWH needs to win ~$600 million of work for FY12 and ~$800 million for FY13. Barnett’s DCF valuation is based on NWH achieving the lower end of its aspirational revenue targets and assumes no fixed cost leverage for the next stage of growth. The stock is currently trading at a 15 percent discount to Barnett’s $2.73 target.
Roger Leaning, Head of Research, RBS Morgans
1) Campbell Brothers (CPB):
Chart: Share price over the year to 27/02/2011 versus ASX200 (XJO)
Leaning expects earnings upgrades to drive the share price ($41.70) in the laboratory operator closer to $50 over the next 12 months.
2) Boart Longyear (BLY):
Chart: Share price over the year to 27/02/2011 versus ASX200 (XJO)
The mining driller returned to profitability with revenue up by 50.9 percent. It launched 11 new drilling products and introduced 94 new rigs in 2010 and expects strong demand for its drilling services and products to create further growth in 2011 - assuming it can overcome potential labour shortage issues. Trading on a 16 percent discount to Leaning’s $5.20 target.
3) Cardno (CDD):
Chart: Share price over the year to 27/02/2011 versus ASX200 (XJO)
The engineering services firm reported a record first-half net profit of $31.717 million for the December 2010 half year, a 97.6 percent increase from $16.1 million for 1H last year. The result follows six consecutive record annual profits and earnings per share growth since listing in 2004. A projected lower workload on the Gulf of Mexico oil spill is expected to be offset by improving conditions across the business and recent project wins. Currently trading at around Leaning’s target price of $5.99.
4) Runge (RUL):
Chart: Share price over the year to 27/02/2011 versus ASX200 (XJO)
Provides mining software and consulting services to the mining technology sector. Leaning regards RUL as an attractive punt that has been overlooked and misunderstood by the market. Trades on a 90 percent discount to his $0.84 target.
5) Sedgman (SDM):
Chart: Share price over the year to 27/02/2011 versus ASX200 (XJO)
Recent sell-down was unwarranted following revelations during its first half announcement that it was experiencing problems with contract execution. While the company's first half margins were below expectations, promising market conditions, and improved operational efficiencies mean it’s well positioned to improve during the 2011/12 financial year. Leaning’s target is $1.93.
6) NRW (NWH):
Chart: Share price over the year to 27/02/2011 versus ASX200 (XJO)
Leaning’s pick of the mining contractors, NWH lifted its first half profit by 33 percent to $20.4 million based on improved performance in the civil, mining and the drill and blast divisions - and boosted its interim dividend by a similar margin to four cents a share.
7) Monadelphous Group (MND):
Chart: Share price over the year to 27/02/2011 versus ASX200 (XJO)
Currently trading at around fair value, but the engineering services provider has a track-record of exceeding market expectations. A strong performance by its core markets of resources and energy saw MND increased first-half profit 12.3 percent. Leaning’s target is $22.94.
