The tide has turned in mining services
In previous editions of Investment Matters, we discussed a recovery in mining services' activity, especially in the context of Emeco. We believed we had observed the start of an uptick in activity as the miners’ cash-driven / debt reduction focus had extended in many cases too far, at the expense of their operations (e.g. plant and equipment maintenance, overburden removal, drilling activity etc.)
Over the last month, it has become increasingly apparent that the recovery in mining services isn’t merely an uptick anymore. We are seeing a clear and broad increase in demand across the resources' sector. Two examples are:
1/ Seven Group, which owns the Westrac Caterpillar franchise, had a share price jump >10% this week on the back of Caterpillar USA’s 2Q update. This update saw revenue increase 9.6% and underlying profit up 36.7% as compared to 2Q FY-16. The company also increased its FY-17 guidance, and saw ‘increased demand across many end markets’. Dealer inventories (pointing to equipment sales) and aftermarket parts (pointing to less equipment being idle) were noted in relation to equipment used in the resources sector.
2/ Swick Mining Services is an Australian listed drilling company. It is a quality operator, with its main operations drilling underground for large and multinational mining houses. We have followed the company off and on over many years, and hold it in high regard. It has been interesting tracking the announcements from the company over the last 6 months or so – with a clear trend of an increased and escalating demand for their services.
EY (the global professional services firm) recently released a report about the mining sector (Does cutting debt have to mean reducing your ambitions?). A quote worth noting: “Companies face the very real risk of letting debt levels fall to lows that create inefficient balance sheets and overlooking necessary investment in projects to generate returns down the road.” In First Samuel’s view, we are seeing a number of companies who fit, or who will shortly fit, this observation.
This is where we see the next step up in relation to mining activity – not just getting back to a sustainable level of activity in relation to current operations, but miners actually making investments for the future. We are seeing some smaller players step into this area, but overall it is pretty limited at the moment.
The timing of a step-up in investment is unpredictable (for us anyway), and would be expected to vary by commodity.
This week Emeco released its fourth quarter activity statement, along with its unaudited FY-17 results.
It was a good announcement, with de-gearing progressing faster than we expected, strong cash flow (excluding merger fees), and the earnings for Q4 (operating EBITDA of $29.5m including one-off costs, see below) providing confidence in relation to the run rate the company is achieving as FY-18 commences.
It was the first quarter of the merged Emeco / Andy’s / Orionstone entity. Therefore, as expected, there were a number of one-off costs, e.g. to bring the equipment from the merger and recent asset swap up to the Emeco operating standard, merger fees, etc. This will turn in FY-18, when merger synergies ($15m expected) will also be realised. Additionally, equipment utilisation was down in the previous quarter (51% vs 56%), as a result of bringing the additional less utilised equipment into the fold.
And this is where the opportunity really lies. Now that we are seeing the increased demand across the mining sector flow through to the newly consolidated equipment rental industry, Emeco is in a great position to be able to increase its average utilisation and thereby capture additional revenue and increase its margins.
Overall, we now expect Emeco to make a net positive profit (including allowance for depreciation) in FY-18, around 2 years ahead of where we thought it would be.
Position in your portfolio
Emeco is a meaningful weight in your portfolio. Therefore the recent positive share price movement has provided performance benefit at a portfolio level.
We see further upside in Emeco’s financial performance and thus share price performance from here – although as always share price movements are almost never linear.
Although the weight in the portfolio has increased in recent times, due the relative share price performance, we remain comfortable with where it stands. In the future, should the portfolio weight get to a point where we assess it to be too high, we will trim the investment as appropriate. Some may recall we had a similar situation in relation to Energy Developments a few years ago – a good problem to have!
We are clearly seeing positive demand in the mining services sector, as miners return to a more sustainable level of spending on their operations. This is benefiting companies such as Emeco.
Emeco's positive fourth quarter activity statement and reported Q4 earnings (for the merged entity) point to a good FY-18 result – certainly stronger than we were expecting.