Emeco's share price
Many First Samuel clients have a holding in Emeco Ltd. Emeco is a mining-services supplier. For example, it leases the big yellow trucks seen at large mines.
The recent share retracement of Emeco’s share price (-36% QTD) has had a marked negative impact on clients’ portfolios. This comes after Emeco was the standout performer to portfolios in FY18 (+267%). Whilst moves in the share price (both up and down) would imply a huge level of volatility within the business, this isn’t the case and simply a reflection of market sentiment (and short term investors repositioning their portfolios) rather than the reality of the business.
In our view, there has been no change to Emeco`s profitability in the last few months, all while the stock price has weakened close to -40%.
Coal producers make up ~50% of EHL's customer base: thermal coal is still $100 USD per tonne and coking $225 per tonne, so their core customers are making substantial profits and will, therefore, continue to require fleet. Additionally, the coal producers had, on mass, significantly under invested in their mines through 2014-2016 (avoiding things like overburden removal). As a result, there is a big volume of earth to move for Emeco's machines in the next 3 to 5 years, to catch up with the long term (stay in business) mine plans.
The important context for Emeco today is that in recent years it has:
1) Taken out a lot of the irrational competitors (of prior years) and consolidated the market. In 2014 these weak competitors were crazy on pricing (pricing to survive rather than make a return on capital) and don’t exist en-mass today.
2) Taken a lot of the volatility out of their business with longer term contracts and better pricing. We believe that rental pricing has now only recovered towards half way (across the book of EHL business) to what it needs to be for EHL to choose to renew its contracts (rather than return capital).
3) Built up a reputation as the quality service provider to the industry, using smart GPS and data techniques to drive customer profitability up (per tonne) in line and in advance of industry best practice.
It is not the same company that it was in the mining turn down of 2014.
With the share price declining (markedly) but the earnings increasing for at least the next two years, EHL has got to the point where it is vulnerable to takeover. The business has a dominant market position in the largest mining market in the world. It also has a private equity majority owner.
It will produce ~$220m EBITDA this year and over >$250m in 2020 which prices it on 4.0x EBITDA for 2019 and 3.3.x for 2020.
To put this in context. After Emeco spends money on replacing machines, paying interest and tax, it should make a cash profit of ~$100m per year (or 7x its current value). If the company choose (as they could after they virtually wipe out there debt by 2020/2021) to pay this out as dividends it would equate to a dividend yield of ~14% per annum.
Why has it's share price fallen then?
The best explanation would appear to be that the recent administration of RCR Tomlinson (an entirely different business and part of the industry) has left a scar on small cap fund managers, as a result we have seen them cashing in many "related" positions in the short term. We have seen this in the market in other companies.
With the stock having only recently transitioned into the ASX300 it is currently on covered by two main stream brokers, and has not yet been picked up by many large cap managers. There are "more sellers than buyers" in the short term.
In the past EHL was a marginal player in the industry and had substantial debt levels. Its substantially improved market and business position is yet to be fully understood by the market to date. If we remain patient, it will either be appreciated as its strengths prevail, or it will be taken over. Either of these likely scenarios will make our patience worthwhile and simply be another footnote in the Emeco journey.
- Dennison Hambling