15/02/2016 - 10:51

Battle on for mining contractors

15/02/2016 - 10:51

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Special Report: Falling commodity prices have led some mining contractors to circle the wagons, but others are cautiously targeting opportunities.

Battle on for mining contractors
CONSERVATIVE: Craig Lindsay-Rae credits Murray Engineering’s conservative strategy for driving revenue growth in the downturn. Photo: Attila Csaszar

Falling commodity prices have led some mining contractors to circle the wagons, but others are cautiously targeting opportunities.

The slump in iron ore prices is being felt in a number of sectors – initially hitting resources contractors hard then flowing through to corporate finance, and even providing work for the legal profession.

While the majority of Western Australia’s mining contractors are managing their way through the downturn with cost reductions and diversification strategies, there has been plenty of red ink spilled as far as shareholders are concerned.

A dollar invested five years ago in a selection of 15 ASX-listed contractors chosen by Business News, each with varying degrees of exposure to mining, would be worth about 14.3 per cent less at the time of writing.

That’s including the impact of dividends and capital gains, and assuming the investment was equally weighted across all players.

Iron ore’s travails are being felt in corporate finance, too, with mining-related activity dismal in 2015 in terms of deals and opportunities (although rising debt levels and falling earnings could lead to potential mergers and acquisitions activity in the year ahead).

Another key trend sure to arouse interest is the increasing level of legal action, with companies taking to the courts to sort out contractual disputes principally resulting from changed economic circumstances.

The area of the broader resources sector providing the most work is gold, with a substantial portion of recently announced contracts awarded by gold miners.

There are some positives for those who have strong, profitable potential projects, in the form of falling labour costs and sharply lower equipment prices.

Key indicators of what’s ahead for mining contractors are steel production figures and iron ore trade data, with that commodity making up the largest share of the state’s resources output.

The World Steel Association’s latest analysis of crude steel production showed a fall of 2.8 per cent in the 2015 calendar year, with China down 2.3 per cent.

Chinese iron ore imports reportedly climbed dramatically in December, to a record 96.3 million tonnes in that month alone, while inventories were restocked at local ports.

Iron ore mine utilisation is low in Asia, with these factors contributing to a recent brief uptick in the price of the ore.

Listed value

The impact of the downturn for shareholders in contracting companies has been devastating.

Those worst hit on the Business News list of 15 were Ausdrill, Macmahon Holdings and NRW Holdings.

The low price environment has also somewhat shaken up the BNiQ contractors’ list, with MACA moving up into second based on WA staff numbers.

Maca employs about 1,350 mining-focused workers in WA, with projects including the Abydos and Wodgina mines owned by Atlas Iron.

First place belongs to Downer, with 1,546 contractors, including work at Christmas Creek and Roy Hill.

Just 18 months ago, when a tonne of iron ore could be purchased at the Chinese port of Tianjin for about $US93, Macmahon Holdings was the top contractor with 1,900 employees on the books.

At that point, Macmahon was working at Christmas Creek with Fortescue Metals Group (a contract it lost to Downer), and at the Rio Tinto Argyle diamond mine, which has since been scaled down.

In the past seven months, NRW Holdings move up, while Byrnecut moved down.

Among listed players, gold was the standout in terms of contracts awarded so far this financial year.

Some of the biggest wins were in the international market, with Ausdrill subsidiary African Mining Services securing two gold-related contracts in Africa, including a $US300 million earthworks and open-pit mining job in Ethiopia.

Macmahon was another to score an international contract, with PT Agincourt Resources selecting it for mining and earthworks at a site in Indonesia.

Despite the commodity’s falling price, iron ore provided the biggest win, with BGC Contracting securing a $520 million, five-year extension with Cliffs Natural Resources for the Koolyanobbing mine.

Another iron ore contract was for Rio Tinto’s Nammuldi iron ore mine, which went to NRW Holdings, while QUBE Holdings had some bad luck, with the BC Iron-led Nullagine Joint Venture halting operations not long after the company won a road haulage contract.

In nickel, GR Engineering Services won two EPC contracts, worth up to $41 million.

Long odds

Privately owned Cape Crushing & Earthmoving moves up one notch to 13th place on the BNiQ list, with about 185 WA mining contracting staff.

Cape chief executive Chris Mallios said although the environment was tougher than 12 months ago, work was still available and the company had won some significant packages recently.

“There is still work across most of the commodity sectors, although there is more in some than others,” Mr Mallios told Business News.

“Part of our growth strategy has been to operate in different (commodities) and we currently have a healthy involvement in projects across iron ore, gold and nickel.”

Mr Mallios said the fundamentals of the iron ore industry were solid, while contractors would need to get used to the new environment.

Cape was diversifying into other sectors, including infrastructure and utilities, he said.

“Because of the focus on efficiency it’s been imperative to engage with our people so they understand the need to find better and more effective ways of doing things, be it via Lean and Kaizen programs or investing in technology,” Mr Mallios said.

Lean and Kaizen are business strategies focused on continuous improvement.

“If you have fairly remunerated, talented and engaged employees it will be easier to set benchmarks, set the targets and then drive the business to achieve the required outcomes,” Mr Mallios said.

CPC Engineering chief executive Glen Weir said there was a lot of maintenance work around, including shutdowns and sustaining capital.

“A large portion of our business is built around maintenance and that’s still ongoing,” he said.

Gold was providing the majority of work opportunities for CPC, while the climate in iron ore and nickel was poor, Mr Weir said.

With a lower Australian dollar and falling input costs, profitability was not too bad for most gold miners, he said, with CPC to pursue a few options in the year ahead.

“I said last year it was going to get worse before it gets better and I think this year has certainly started off in that vein,” Mr Weir said.

“I can’t see it turning any time soon.

“I’m a Kalgoorlie boy and I still wouldn’t bet money on it.”

Conservative strategy

Pinjarra-based Murray Engineering managing director Craig Lindsay-Rae said there were unparalleled headwinds in the market.

Murray has focused on diversification across commodities, particularly gold, alumina and copper, to contribute to revenue growth in an otherwise declining market.

The company wasn’t focused solely on major short-term expansions for single projects, he said.

Mr Lindsay-Rae said one of the critical elements for a contractor like Murray Engineering was utilisation rates of labour.

“About five years ago we were recovering about 70 per cent of the available labour that we had,” he said.

“Last year we recovered about 89 per cent of total available time.

“We’re almost at full optimisation of our labour pool.”

He said that was really the difference between profitability or loss making.

A year ago, Murray Engineering introduced a new underground mining contract that took some risk on costs and machine availability, with Mr Lindsay-Rae saying that decision could be made because Murray had collected a lot of data about costs.

“We’re a conservative company in terms of capital expenditure and overhead cost control,” he said.

“Our working capital controls have always been very well managed.”

Mr Lindsay-Rae said the company held off from buying new equipment at the peak, and was able to purchase now, near new, much more cheaply.

Deals, dollars and debt

Debt-to-equity ratios vary substantially across the industry, with McAleese Group, at 155 per cent, among the highest.

The trucking contractor confirmed in early February that it was considering a potential recapitalisation as part of a strategic review, with multiple parties expressing an interest in that process; one of these was McColl’s Transport, an entity controlled by private equity player Kohlberg Kravis Roberts.

Others with debt ratios above the industry average included NRW Holdings and Ausdrill.

KordaMentha restructuring partner Cliff Rocke said companies that were highly leveraged would face the most trouble.

As one simple example, payment terms had been changed by many big companies from 60 to 90 days.

That would affect smaller, downstream providers with weaker balance sheets.

“I think we’re going to see some fallout,” Mr Rocke said, adding that contractors faced almost a perfect storm. He predicted that it could lead to some activity in the mergers and acquisitions sphere.

However, larger companies might just let smaller ones be taken out by the tightening market and bid for the work themselves afterwards.

“It’s going to be basically companies that have got good reputations in terms of delivery of work, reliability and sound reputation or specialisation  but have got a weak balance sheet that is hampering expansion,” he said.

“It’s a bit of a twisted edge in terms of where it’s going andf how it’s going to end up. If you’ve got a strong balance sheet, you’ll be able to ride this storm out.”

Alternately, those with weak balance sheets and high fixed-cost structures could be in trouble.

An example of this was among heavy haulage companies, which had lower demand, high fixed costs and a more specialised offering.

The important thing for mergers would be that they would work only when synergies and efficiencies could be established, Mr Rocke said

“A merger is only going to be good if one plus one equals three,” he said.

At the start of 2016, Maca bought Alliance Contracting for $5 million, a company that provides open-cut mining services for Metals X and Silver Lake Resources.

At the time, Maca chief executive Chris Tuckwell touted the increased exposure to gold and a $50 million injection to the company’s order book as drivers of the deal.

Jostling for position is also going on between CIMIC Group and Sedgman, with the former offering more than $240 million for the Brisbane-based contractor.

Equipment oversupply

A further predictive indicator of activity in the sector is the yellow goods market.

EY Oceania mining and metals transactions advisory leader Paul Murphy said the company’s recent report on that market revealed a disconnect between mining and construction equipment values in the past year.

He said reduced demand for rental and contract services was ultimately flowing on to an oversupply of secondhand equipment, with both local and imported equipment under pressure.

Clearance rates were up, however.

Two years ago, volumes plummeted when companies expected a short-term recovery and opted to hold on to stock, while it is now becoming clear this will not be the case.

“Those that have capital and are cashed up are starting to get into the market,” Mr Murphy said.

International buyers, particularly from the Middle East, were one such group.

The EY report highlights an 8 per cent recovery in the value of low hours, late model secondhand construction equipment in 12 months to September 2015, while there were steady values for high hours equipment.

Over a two-year period, however, both were down.

By comparison, mining-specific equipment suffered badly.

There was a 30 per cent fall in the value of late model equipment in that 12-month period, while measured over two years it was down 37 per cent.

Higher hours equipment fell in value by 22 per cent.

For a mid-tier operator, the value of an average mining fleet would be down nearly two thirds since its peak, EY estimated.

Mr Murphy said there were benefits from this, including lower capital costs for those wanting to start a mine.

Lower capital costs would additionally reduce the threshold for mines under care and maintenance to return to production.

A further measure, the Alleasing equipment demand index, found that only one in 10 mining and resources businesses in Australia planned to acquire yellow goods in the first quarter of this year.

That was less than half the portion that was keen to buy this time last year.

There were sellers, however.

More than a quarter of mining and resources companies would aim to decrease their asset base in the first quarter, Alleasing found.

Labour market

There was a similar theme in the labour market.

Hays Specialist Recruitment Australia regional director of resources and mining, Chris Kent, said the labour market for contractors was softening, although perhaps not as much as some expected.

He said the latest statistics from Seek indicated that WA mining and resources job advertisements were down 7 per cent in the past year, compared with 16 per cent nationally.

Those numbers are largely for operations-related employees, however, with construction job ads down 42 per cent, he added.

Mr Kent said it indicated the construction phase of the boom was well and truly coming to an end.

In a familiar theme, gold was shining brightest in terms of employment demand by commodities.

“In WA at the moment, in terms of the opportunities, they’re all around gold – that’s been the case for a long time now,” Mr Kent said.

Some related skills were actually in shortage, with examples being experienced processing technicians.

Other key trends included the continued move towards temporary workers, with vacated permanent positions being replaced by contracts, and a heavier reliance on all-rounders in place of specialised employees.

Court battles

Business News understands that some companies are bidding to break even on contracts, with the view that they can make a substantial amount from variations.

A notable example is the dispute surrounding the Roy Hill iron ore project.

Samsung’s contract  with Roy Hill Holdings had been worth $US5.8 billion, with the South Korean company booking large losses on the project in its 2015 annual report.

A dispute with NRW involved extra work and scope on a 330-kilometre railway build, with Samsung not making progress payments for the contract beyond March.

The original contract was valued at $600 million, with the company reporting a loss of about $70 million from the contract in its annual report.

Samsung and NRW eventually agreed to a $30 million settlement, after two Supreme Court rulings.

At the company’s annual general meeting in November, chairman Ian Burston said it had been a disappointing and depressing experience, which had led to a range of cost-cutting measures. 

NRW wasn’t the only contractor involved in legal battles, however.

Laing O'Rourke’s Roy Hill contract was mutually terminated early last year, with Samsung C&T and Laing fighting over responsibility for delays in work at the project’s port.

The Supreme Court of Western Australia concluded hearing the case last week. A judgment is expected soon.

In December, liquidators of Forge Group, which ran aground two years ago, found financial backing for a claim against former major shareholder Clough.

Clough sold out of Forge in 2013, while a further shareholder action stemming from the collapse is ongoing.

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