Contracting sector turns it around

The worst might be over for many of the state’s mining services businesses, as they seek to bounce back from the effects of the slowdown in resources project development.

Engineers and mining-service providers were the main contenders for last year’s wooden spoon in terms of the worst performance of any stock market sector, which was hardly surprising given the dramatic contraction in resources project development.

Look again.

Out from the basement is emerging a group of companies well on the way to being among the best performers on the market, with some doubling their share prices (and better).

There is, of course, a caveat when considering the 150 per cent share-price rise by mining contractor Macmahon Holdings (from 4 cents last June to around 10 cents today), which is that the starting point for the calculation is exceptionally low.

That Macmahon has survived its brush with death can be seen in the price recovery, with its shares touching a two-year high of 14 cents in mid-March before easing back to its current price as investors digest the strength of the revival and consider the outlook for the company and the rest of the mining services sector.

Macmahon is not alone. The share prices of other engineers and service providers have also moved higher as sentiments towards a beaten-down sector improves.

The share price of Ausdrill, which operates a large fleet of mineral drilling rigs, risen by 183 per cent from a low of 18 cents as recently as early February to recent sales at a 12-month high of 51 cents, before easing back to around 49 cents.

Mineral Resources, which is exposed to mining services as well as being directly involved in mineral production, has enjoyed a 126 per cent share price rise, from a low of $3.34 as recently as mid-January to $7.56, a price that puts it within striking distance of its 12-month high of $7.72 set in May last year.

Monadelphous Group, a broadly diversified contractor with mining, energy and maintenance divisions, is also in recovery mode, but with a share price up by a more modest 42 per cent from a multi-year low of $5.32 late last year to recent sales at $7.55.

Those four examples – Macmahon, Ausdrill, Mineral Resources and Monadelphous – have a long way to go before reclaiming their share-price highs reached during the boom years, a time when all benefited from the sky-high iron ore price and seemingly ceaseless round of project developments.

Macmahon was trading at $1.95 in November 2007, which means today’s share price of 10 cents represents a 95 per cent fall during the past nine years. Ausdrill shares hit $4.21 in March 2012, which means today’s 49 cents is a fall of 88 per cent. Mineral Resources is roughly half its high of $13.48 reached in early 2011, and Monadelphous is down 72 per cent from its 2013 high of $27.60.

However no-one can say that the business of selling mining and engineering services to the mining and oil industries is enjoying buoyant times.

There are still obstacles blocking a full-blown recovery, Fortescue Metals Group’s move to switch from a contractor to using its own staff and equipment at the Christmas Creek mine a change that might be followed by other miners, depending on whether a cost saving can be achieved.

Losing the Christmas Creek job hit the share price of Downer EDI, one of Australia’s biggest mining contractors, with its share price dropping 10 per cent on the day the move was announced (April 5) to $3.38.

Downer’s share price has recovered to recent trades at $3.79, and the stock is substantially higher than its 12-month low of $2.77, but the loss of a big contract was a warning for all contractors that only the most competitive will survive in the current market.

Brierty, one of the smaller ASX-listed contractors, has made significant changes to its business model in recent months, shedding 14 positions (about 20 per cent of its corporate office) while promoting former state Liberal politician Troy Buswell. Investors are unimpressed by the moves, with Brierty’s share price struggling at 13 cents, 1 cent above its 12-month low.

Financial strife at Brisbane-based Ausenco is another sign of ongoing pressure after two years of losses; though it is significant that a private fund manager, Resource Capital Funds, has launched a takeover bid, which is an indication that professional investors see future value in the business.

Cleaning up the problems caused by boom-time excess – such as investing too heavily in new equipment, incurring unsustainable levels of debt, employing too many people, and assuming that sky-high contract rates could continue indefinitely – is an ongoing challenge for contractors.

However the latest evidence points to the worst being over, thanks to a combination of severe cost cutting, first signs of a revival in commodity prices, the emergence of ‘hot-house mineral flowers’ such as lithium and potash as exploration targets, and the remarkable strength of the metal which has saved WA repeatedly in the past – gold.

When combined, this new base of lower costs, the gold revival and a healthy flow of fresh capital into exploration for new commodities is starting to plug a hole left by the collapse in iron ore exploration and development.

In Macmahon’s case, the contraction to a size that meets business opportunities can be measured in human terms – a 59 per cent drop in employee numbers, from the 2,885 on the payroll at December 2013 to 1,179 last December.

The painful process of shrinking to fit the market can also be measured by the value of Macmahon’s order book, which was flying high at more than $3 billion five years ago but had declined by 50 per cent to $1.5 billion when the company filed its latest set of half-year accounts in mid-February.

The Macmahon story is repeated across the engineering and mining services sector, with a severe contraction in work on hand forcing a period of dramatic restructuring, heavy job losses, shrinking order books, and tight profit margins.

But the Macmahon situation is also a pointer to what might be better times ahead, both in the rising share price and the strength of underlying business, which is undoubtedly a lot smaller but also well positioned to grow from its new and lower base.

A few numbers tell the Macmahon story as it stands today. Despite tough markets and tight margins, the company was able to post a modest profit of $3.3 million in the latest half year on revenue of $174 million. Cash generated in the half year was $11.7 million and cash in the bank stood at $66.7 million.

That cash position compares with a market value for the company at 10 cents a share of $122 million, which means more than half the value of the business is represented by cash.

Ausdrill has a similar story to tell. After its hammering on the market the underlying financial performance is improving, with a profit in the latest half year of $9.3 million markedly better than a loss of $177 million in the opening half of the 2015 financial year.

Debt repayment has been a priority for Ausdrill, with $46.5 million repaid in the December half, reducing gearing to a more manageable 36.3 per cent and lifting the return on capital from a lowly 2.7 per cent to 6.4 per cent.

Significantly, the type of work carried out by Ausdrill has shifted towards growth segments of the mining market. In the first half of 2015, 20.6 per cent of the company’s drilling and other services was related to iron ore. That dropped to 10.9 per cent in the latest half. Work on gold and copper grew from 66.2 per cent to 82.6 per cent, a guide to where exploration and mine development is heading.

Monadelphous, which suffered a 30 per cent fall in revenue in the latest half-year compared with the previous period of 2015, along with a 34 per cent fall in pre-tax profit, warned that the Australian market remained challenging ‘with customers minimising capital and operating costs’.

One company to disagree with that note of caution is a new kid on the contracting block, Tempo Australia.

A virtual unknown, Tempo is operating in the conventional contracting space – a mix of civil, mechanical and electrical engineering services, with the resources sector a major source of work.

Over the past 12 months as more established contractors have been looking for cures to the post-boom hangovers, Tempo’s share price has rocketed along, rising by 575 per cent from 4 cents to 27 cents, thanks to a combination of its newcomer status and its experienced management team led by Charlie Bontempo, a founder of the successful United Group (UGL) and former managing director of Monadelphous.

Without the baggage of the boom to weigh it down, Tempo is expected to enjoy a strong increase in revenue and profit. Local broking firm Euroz Securities has tipped a revenue rise from $79 million last financial year to $101 million this year, with profit rising from $3.5 million to $5.3 million.

Tempo’s growth and the recovery in a number of other contracting companies is proof that a recovery is under way; and while it will not be a quick rebound, at least the slide has stopped for most companies.