A rare upgrade

A rare upgrade

Warren Buffett famously stated, “A rising tide lifts all boats. It’s not until the tide goes out that you realise who’s swimming naked.”

Mining services companies have indeed been riding high in recent years on a wave of capital flowing into Australia. Miners accelerated production to capitalise on strong commodity prices, and mining servicing companies rushed to secure contracts with little attention paid to their cost base.

But we all know how sharply the environment has changed. Commodity prices have fallen since the start of the year, causing many of these projects to be abruptly shelved. The tide fell as quickly as it had risen, resulting in a raft of downgrades from mining servicers.

It is during downturns that quality companies rise to the surface, as miners now have the discretion to award projects to the most competitive contractors. This week, we have seen a rare upgrade.

Clough is an engineering and project services contractor that is predominantly exposed to the major oil and gas projects in Australia and PNG. During the boom, Clough was one such contractor that had a greater focus on securing contracts rather than maintaining an efficient cost base. But to management’s credit, the company has not only been able to secure further projects, it has also managed to trim the cost base and maintain profitability during this period.

Clough announced in May that it has secured revenue for FY13 of $1.43 billion, upon which it was expecting to generate Earnings Before Interest and Tax (EBIT) of between $80 million and $85 million. The company has just upgraded EBIT for FY13 to $90 million on $1.5 billion of revenue. This equates to an EBIT margin of 6 per cent (the company’s EBIT margin in FY12 was 3.7 per cent).

At Montgomery, we still believe that exposure to miners and mining services carries too much risk (you can scroll through the numerous articles here at the blog to see why). But this doesn’t mean that some quality operators will not perform well. We believe it is inevitable that through receiverships and liquidations, for example, there will be fewer operators who capture a larger share of the remaining work. Clough has secured revenues of $1.35 billion for FY14, and if management can achieve a long term EBIT margin of 7 per cent, it will place the company in an enviable position within the sector.