Investment cycles and Emeco in the news
The Investment Cycle of the Resource Sectors
Your Investment Team has spent some time this week considering the capital investment cycle in the resources sector (mining and energy). (We may present a more detailed piece on this in Investment Matters next week.)
The mining investment boom peaked around 2012, with the energy sector a little later because of a number of large LNG projects. Capital spending has subsequently declined considerably (impacting not just the resource sector, but Australia's economy more broadly).
The RBA has noted that "the end of the fall in mining investment is coming into view"*. This is also shown by the graph from the RBA below. Other analysis, for example by Goldman Sachs**, has assessed that the bottom of the cycle has been reached, but a slow recovery is expected.
This also makes sense, particularly for the mining sector. Most miners have been operating on the smell of an oily rag, so to speak, for quite a while (2 years+). There is only so long, for instance, that equipment replacement can be delayed, or low grade easy access ore can be mined. Whilst we do not predict new large spend greenfield mines in the short or even medium term, we do predict a slow upturn in mining related capital spending.
Which feeds into the newspaper reports this week about Emeco. We consider the rumoured debt restructure and merger transaction leaked in the AFR and The Australian newspapers this week as occurring at an opportune time.
Emeco Merger and Debt Restructure
We understand that Emeco is close to signing an agreement with the company’s debt financiers, and the shareholders and creditors of Orionstone and Andy’s Earthmovers (Andy’s).
The agreement is for the recapitalisation of Emeco, and for a concurrent merger with Orionstone and Andy’s.
This could be a company changing event. It would mark a significant turn of affairs for the business, which has been struggling with poor equipment rental rates for a couple of years (in the challenging conditions of the resources sector). That said, in FY-16 the business improved EBITDA by 25% to $54.2m over FY-15 despite these tough conditions.
A transaction such as this would allow Emeco to restructure and reduce its debt (which would be extended by 5 years). A merger would also create significant operating (lower costs per $ of sales) and capital equipment synergies (we believe Orionstone and Andy’s have younger fleets – meaning less short to medium term capital expenditure).
This would allow Emeco to generate significant free cashflow (per share), and possibly also lead to a more stable industry.
Currently Emeco is in trading halt, and we expect an announcement or update on Monday. We will wait to see final terms and details then, but definitely see this as a positive development for the company and the industry.
*Speech by Christopher Kent, Assistant Governor (Economic), 13-Sep-16.
**The Mining Capex Cycle, 14-Sep-16.