Australia | Sep 11 2008
By Andrew Nelson
Mining and exploration services companies have be the flavour of the last few months, but a pair of broker downgrades doled out to Boart Longyear ((BLY)) this morning signals a shifting in taste, bring the industry in-line with the broader outlook for the resources sector.
Four brokers have chipped in with their 2c worth since yesterday’s news that Major Drilling, a key competitor of Australian mining services company Boart Longyear, booked a record 1Q09 result. The Canadian company recorded higher prices, therefore booking higher margins and talked up demand, saying biggest problems was finding crews in Canada, the US and Australia to actually do the work. It was a good quarter, no argument.
And what goes for Major Drilling also goes for Boart Longyear, who booked a “strong” 1H result a few weeks back, making many of the same comments and observations as its peer and drawing nary a negative comment from any of the Aussie brokers.
Yet the share price lost nearly 10% from the time it announced its “strong” 1H result on August 26 to the day before we had the “strong” 1Q read from Major Drilling yesterday, going from $1.99 to $1.80. Since then its been a lot worse, with an almost 20% drop in the last two days, down from $1.80 to $1.45 as I write this. That’s about a 27% fall in two weeks, with nothing but strong results to point to.
So what’s the problem here? In one word, sentiment!
When it comes to the resources sector, investors have smelt fish, and mining services companies are also therfore smelling fishy. We keep being told that miners are going to do it tough and while recent capex figures showed that the mining sector is going to keep spending, much of that money is going to come from the deep end of the pit. From the big guys.
Boart Longyear said a few weeks back that it’s expecting quite a bit less from the shallow end of the pool, as smaller players find it tougher and tougher to get the funding to develop. Why? Well that’s a tune we all know. Tighter credit conditions, a lack of appetite for leveraged plays and the prospect of diminishing returns as metal prices and now even oil prices plummet to record lows from the record highs that generated the “strong” results for both companies.
Add to that a slowing China, which exacerbates an overall decreasing demand for resources due to a global economic softening and we’ve really got something to think about.
But this is all old news, so what’s new? Yesterday, Major Drilling underscored the weakening outlook, saying softer demand in the Junior sector was now actually starting to emerge.
This is what got the alarm bells ringing yesterday and saw both ABN Amro and Macquarie slap a downgrade to Hold/Neutral on Boart Longyear this morning.
On Macquarie’s numbers junior miners have created a broad based platform for exploration spend, representing around 50% of total spend in the sector.
The broker is far from harsh in its assessment, saying that BLY has only limited exposure to the junior end of the market, about 30%, with half of them indirectly funded by the majors that represent 70% of its business. The broker also thinks the company’s larger scale and geographic diversity will also see it better placed than its peers.
Citi, who have been negative on the stock for a while now, are more pessimistic in their outlook, saying this beginning in the downturn of the junior sector could mean “something much more sinister”.
On its numbers, 60% of industry exploration budgets come from juniors, noting that juniors have been burning other people’s money with little results. If the credit crisis continues, many a junior may not even survive and bang goes 60% of the market.
Either way, less business means more competition, more competition means lower prices, lower prices means lower margins. Add the expectation of less demand, also resulting in lower prices and margins really come under pressure. So even if Boart Longyear manages to hold its own, margins will most likely decrease and earnings will eventually slide.
While ABN Amro thinks the impact of decreasing margins can be cushioned to some extent but cutting costs, especially in the labour force (although this is dicey as the company’s viability depends on its ability to attract and retain skilled workers.), it expects longer-term price trends will still be weakened. Hence, earnings impacted.
This is where we get to the meat and potatoes. ABN Amro has cut its FY09 earnings expectations by 5% and FY10 by 7%, Macquarie by 10% and 14%. Macquarie also notes a recent share sale by management didn’t help already negative resources sector sentiment.
The FNArena sentiment indicator is sitting at 0.3 now, with 4 Buys, 3 Holds and one Sell from Citi, who had a Sell before the 1H result and has kept it on post the Major Drilling announcement. Two of the Holds are new, from Macquarie and ABN who dropped from Buy, while of the 4 Buys, only JP Morgan has reviewed the news from Major Drilling.
Targets range from JP Morgan’s $2.56 to ABN’s new $1.80 (was $2.30), while Macquarie came down from $2.44 to $1.96. As at 1230, shares in Boart Longyear were down 10.5c, or more than 6.5% at $1.505 versus a 12 month trading range of $1.615 to $2.75.