Heavy Weather For Mining Services/Contractors In FY13 And Beyond

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-Spending downturn hits mine contractors
-Diversity is key to spreading impact
-Preferences home in on Downer EDI
-Monadelphous finding it hard
 

By Eva Brocklehurst

FY13 is going to be a difficult reporting season for mining contractors and the mining services sector. Deutsche Bank has minced the figures, noting the global minerals exploration market has grown from US$1.9 billion in 2002 to US$21.5bn in 2012. The broker's analysis suggests long-term global exploration spending will trend around US$15bn, or 30% lower than 2012 levels. That will impinge on those providing mining services.

Deutsche Bank evaluated historical junior miner spending, assuming that, from 2012 levels, exploration spending will fall by 73%. In the gold sector, exploration spending is expected to be down by 20%, with growth in jewellery and industrial demand being offset by reductions in investment and central bank demand. Copper exploration spending is seen increasing by 3%, in line with global GDP, while other commodity spending is seen falling by around 20%.

In this regard, JP Morgan is seeking out those in the contractor and mining services sector which have the best spread of exposures. Falling commodity prices and increased demand by investors for cash returns from the minerals industry has meant miners have curtailed capital expenditure and contractors with recurring elements to their contract and operations are best placed. JP Morgan notes a clear difference between those linked to mine production volumes against other operations and maintenance businesses that are still facing cut-backs as non-essential spending is deferred. 

A case in point is Bradken ((BKN)). Demand for mining consumables linked to production volumes has held up well for this operator. Also, Seven Group's ((SVW)) WesTrac is resilient. Continued strength in underlying production volumes suggests operating hours for heavy equipment are holding up and this supports demand for maintenance/parts and the replacement cycle.

Within the ASX100 coverage JP Morgan eyes Lend Lease ((LLC)) and Downer EDI ((DOW)), giving them an Overweight tag. Lend Lease's sheer size and low resources exposure is expected to shield the stock from the worst ravages of the mining downturn.The recurring themes of delay, scope cut-back and margin squeeze is part of Macquarie's thesis. In particular, achieving guidance for FY13, the quality of the underlying results (on cash flow and balance sheets) and the outlook for FY14 will garner most attention.

Macquarie also highlights Downer EDI as a positive, expecting the company to deliver on FY13 guidance with good second half cash flow. The earnings outlook for FY14 is expected to be flat. UGL's ((UGL)) result should reveal improved cash flow, albeit on a very weak first half. Gearing will likely be at the upper end of the company's 25-35% range because of around 80% in US dollar denominated debt. Macquarie expects a 20c final dividend, well below the prior year's 36c. 

JP Morgan relegates Monadelphous ((MND)) and WorleyParsons ((WOR)) to Underweight. Monadelphous may deliver on revenue growth guidance but, within the result, weaker margins will produce less at the profit level. Monadelphous' declining earnings profile over the next 12 months will make things hard and Macquarie rates it Neutral. Macquarie expects the second half cash flow will likely be down on the prior corresponding half but will show some sequential improvement. It's the FY14 forecast that will be of interest and the broker forecasts a 10% fall in FY14 revenue. In contrast to JP Morgan, Macquarie has an Outperform on WorleyParsons, hailing the attractive offshore exposure, although admitting the weakness in oil sands and resources are risks for FY14.

Ex-ASX100, JP Morgan likes Bradken, Seven Group, Ausdrill ((ASL)) and NRW Holdings ((NWH)). NRW's strong relationships with key blue chip customers in Australia positions the company as a preferred provider.

Gold mining is the toughest place to be, it seems. BA-Merrill Lynch suspects that, with the gold price around US$1,200/oz there is around 20% of worldwide production that is uneconomic and the industry will need to cut capital expenditure and capacity. The negative impact from this should be felt by services providers ALS ((ALQ)) and Imdex ((IMD)) and contractors Ausdrill, Boart Longyear ((BLY)) and Emeco ((EHL)). Based on the more bearish outlook, Deutsche Bank has downgraded ALS to a Sell, believing market forecasts for FY14-FY17 are too high and the stock looks expensive relative to both the market and peers. Merrills believes earnings impacts from rapid declines in miner sales will affect ALS, Boart Longyear and Imdex in particular. Those that have increased gearing to support fleet expansion, such as Ausdrill, Emeco and Boart Longyear, are expected to feel the pinch at the bottom line.

Among larger stocks, Leighton Holdings ((LEI)) is expected to reiterate full year guidance of $520-600 million but Macquarie suspects first half operating cash flow will be poor because of the increase in under-claims while gearing is still relatively high. Transfield Services ((TSE)) will also be scrutinised for cash flow and gearing. The group is due to refinance $242m in syndicated debt maturing in December. 

JP Morgan believes that, despite the pull-back in spending, Mineral Resources ((MIN)) should achieve 15.2% earnings growth to $238.8m in FY13. Crushing services and process minerals are benefitting from the ramp up of production at recently completed mines, increasing demand for these services. Looking ahead, earnings will largely be driven by iron ore pricing and the successful increase in production for mining. Of the small caps, Macquarie prefers Clough ((CLO)) in the oil and gas services sector while RCR Tomlinson ((RCR)) is also rated Outperform considering its iron ore, power, and oil and gas exposure.
 

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