Mining services this reporting season

Mining services this reporting season

Following on from Ben’s post last week on Boom Logistics Limited (BOL), three other mining services sector-related businesses have also reported so far.

In order of announcement timing, COF, BKN and CGH are briefly covered below after a more formal review by the Montgomery Investment Management Team.

To summarise, despite all their share prices bouncing post their result announcements, we are generally underwhelmed by how we see the next 12-24 or more months playing out for them. Here’s why.

The first to report was Coffey International Limited (COF) which locked in a favourable 12-month turnaround result to 30 June 2013 with $688.4 million total revenue and for 2014, contracted fee revenue of $100 million in Geosciences, $14 million in Project Management, and $73 million in International Development. A contracted amount similar to the same time last year.

We have anticipated that the sector will generally report well given full order books secured back in 2012, when the market was buoyant. Revenue targets are all but locked in, and contracts have been secured on historically attractive margins.

Our experience tells us that generally, contractors can point to their pipeline of future work to reassure the market that they will be able to meet current year expectations. But the pipeline can dry up quickly for companies at the mercy of projects being deferred or cut back.

Given the long lead times required to mobilise labour and equipment, we’d prefer to see at least 60 to 70 per cent of a business’s order/revenue book contracted and underway at their result announcement. If the balance is secured and underway by the second half, it gives us a reasonable level of confidence that the business will at least tread water.

All therefore appears to be OK on face value with Coffey until you consider that less than 30 per cent of its revenue (when compared to $688.4 million revenue in 2013) is contracted for the coming year; a year in which we foresee securing new work being much more difficult.

Based on this result, a bit of blind faith therefore appears to be required to invest in Coffey given very low ‘earnings visibility’. Indeed with management stating “there is no doubt, conditions remain tough, particularly for Geosciences in Australia, so it is prudent not to provide any specific earnings outlook at this time”, we don’t view it is an attractive investment opportunity. This year is likely to be tough for them and we don’t think they will be alone.

The second company to report was Bradken Limited (BKN), with a result that seemed to impress the market – or perhaps it just wasn’t as bad as everyone thought it would be.

With this result comes a plan to focus on its key strengths on the design, manufacture and supply of consumable products to the mining, energy and rail industries, which is perhaps what you would expect.

But the fact that Bradken expects FY14 to be broadly comparable with FY13 doesn’t sit well after some thought. While it might be achievable, we see considerable downside risk to an otherwise ‘steady as she goes’ outlook.

Management currently expects the first half to be soft but a stronger second half will see the business stand still throughout 2014. So the immediate question that springs to mind is: can Bradken achieve a hero final 6 months and tread water in the 2014 financial year? RIO might provide the answer.

They have already highlighted the huge price savings they are getting on consumables from some of Bradken’s international competitors. And given that RIO and others are continuing to focus on cost-cutting measures, RIO doesn’t seem as confident as Bradken’s outlook statement.

Connecting the dots is part of the job we do at Montgomery, and we do find it curious that some other investors focus solely on the statements of one company without considering those of related companies when making their investment decisions. At Montgomery, we don’t have much confidence in Bradken as a potential investment candidate at this time.

The third mining service related company to report was Calibre Group Limited (CGH). Having missed their IPO profit guidance, it’s a business with a relatively short but checkered history as a listed business.

Initially on face value, it has been the standout so far. They reported a slightly better than expected turnaround result and a broadly positive outlook. Here management are confident of maintaining (not growing) earnings into FY2104 assuming no further deterioration in the sector. And with an order book which is 88 per cent contracted at 2013 revenue levels, broken down into $432m in non recurring orders and $193m in recurring maintenance contracts, indeed they appear well placed.

An almost full order book is a great position to be in at the start of the financial year for a contractor. Given our concerns we were pleasantly surprised to see such a large number, given the business’ well-documented hiccups since being listed.

Digging a little deeper, we find that the business made a number of acquisitions in 2013. Indeed it made one very large one with well-secured longer-term maintenance contracts (about $200m) and a further ~$100m in short-term work. So things aren’t very clear-cut on this one either.

Anyone can purchase a ‘rosy’ outlook for the preceding 12 months, but what will happen after that is anyone’s guess. If Calibre’s track record to date is any guide, this again is not a horse we are willing to back right now.

Whilst we have painted quite a negative view of the companies above, their share prices could continue to rise as a few market participants are lured back, thanks in part to optimism about a turnaround and ‘stimulus’ in China. The short-term ‘voting machine’ in action.

If we were traders and shorter-term position takers, which we are not, then perhaps some higher risk ‘cigar puffs’ are possible out of the above and those who are yet to report. This however is akin to gambling, and something we claim no special skill or ability in doing.

Given earnings generally drive share prices over the longer term however, and given falling earnings are unlikely to produce a satisfactory return outcome for our portfolios, we will continue to position ourselves for the long-term, and hence we have decided for now to largely steer the Montgomery funds away from mining services.

We will of course watch future announcements closely, and may change our view should a quality opportunity present itself.