Small Caps | Aug 16 2011
– Imdex delivers solid full year result
– Most brokers suggest stock offers value
– BA-ML more cautious given weak equity markets
– This poses a risk to exploration spending and earnings for Imdex
By Chris Shaw
Drilling fluids and services group Imdex ((IMD)) reported full year net profit of $29 million, which was an increase of 197% on the previous corresponding period. The earnings growth was thanks to a strong recovery in global exploration activity and associated demand for the group's drilling fluids and instruments.
As Deutsche Bank notes, revenue growth for the period was 53%, which means Imdex enjoyed stronger margins in FY11. The tax rate for FY11 was also lower, so in Deutsche's view the adjusted result was broadly in line with expectations for the period.
On the back of the result, management at Imdex has indicated FY12 should deliver further gains as a result of both higher revenues and further margin expansion. Also supportive, notes Deutsche Bank, is an ongoing positive outlook for drilling activity and potential gains from Imdex delivering new products and services.
Given such an outlook Deutsche has made minor increases to earnings estimates through FY14. In earnings per share (EPS) terms Deutsche now expects results of 20c in FY12 and 24c in FY13, up from the 16c delivered in FY11.
As stockbroker Moelis notes, there should also be some earnings growth from the recent ADS and System Mud acquisitions, the deals adding to both drilling fluids manufacturing capabilities and Imdex's presence in the Latin American market.
Assuming no adverse weather conditions in Queensland in particular, Moelis is expecting solid earnings growth in FY12 and has also lifted EPS forecasts by around 3% in coming years. Moelis is now expecting EPS of 20.7c in FY12 and 24.1c in FY13.
BA Merrill Lynch is broadly in line with its EPS estimates for Imdex of 20c in FY12 and 25c in FY13, but suggests a lower earnings multiple is warranted at present as a thriving exploration market needs both strong metal prices and strong equity markets and the latter is currently lacking.
On the plus side BA-ML has not reduced earnings forecasts to reflect less than ideal operating conditions, largely because current earnings momentum is being driven by budgets already set and there is a lag of around one year between equity market movements and exploration budgets.
But given the current environment, BA-ML suggests an appropriate earnings multiple for Imdex is around 10 times, as this would be one standard deviation below the mean for the small cap industrials average.
To reflect this BA-ML has cut its price target for Imdex to $2.20 from $2.66, the broker's revised target well below the consensus price target according to the FNArena database of $2.50. Moelis is not in the database but has a target of $2.60 per share on Imdex.
On the back of its lower price target, BA-ML has downgraded Imdex to Neutral from Buy, while RBS Australia, Deutsche and Moelis all retain Buy recommendations. The key reason for BA-ML's downgrade is the correlation between minerals exploration budgets and equity markets.
As junior miners, which account for 30-40% of total minerals exploration spend, rely on equity capital markets to fund growth, an equity downturn limits the ability of these companies to raise funds. This impacts on overall budgets in the following year.
However, RBS suggests overall most mining balance sheets are extremely healthy, something expected to support a positive outlook for global exploration activity over the next two to three years. As well, RBS points out key commodity prices, gold in particular, have remained at elevated levels despite the recent market volatility. This is seen as another positive for exploration spending.
On RBS's numbers, Imdex trades at a 10% discount to the Small Industrials sector, which is enough to justify a Buy rating given still strong end markets. Moelis agrees, pointing to potential upside bias for earnings from bolt-on acquisitions and from expected improved performance from the Oil and Gas division.
Imdex shares today are slightly higher and as at 11.10am the stock was up 3c at $2.18. This compares to a range over the past year of $0.775 to $2.49. The current share price implies upside of around 14% to the consensus price target in the FNArena database.
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