Australia | Oct 21 2009
By Chris Shaw
With mining sector activity again picking up as the Australian and global economies recover, the need for accomodation for mine workers is also growing, which is good news for The Mac Services Group ((MSL)) as one of the leading players in this sector. Credit Suisse likes the outlook enough to initiate coverage on the stock with an Outperform rating and $2.60 price target, which is based on the average of its discounted cash flow and earnings before interest and tax valuations.
What attracts the broker to the company is it offers long-term growth potential from its exposure to the mining sector, while at the same time generating less cyclical revenues than the mining services stocks given the contract nature of their operations. As an example of this, Credit Suisse notes the company delivered earnings per share (EPS) growth of 18% and 19% in FY08 and FY09 respectively, while expected modest growth of around 3% in FY10 despite far tougher conditions on the back of weaker activity in the sector should be a result better than many others operating in the mining services space.
Currently the company’s operations are centred on the Bowen Basin where it has six wholly-owned accommodation villages and there are early signs of a recovery in production volumes in the area, while expansion also remains a possibility as the broker notes a number of new mines in the region are currently in the advanced planning stage. This should drive an increase in room numbers, its estimates suggesting demand could see 450 or more new rooms in FY11, rising to 550 rooms in FY12.
There are long-term growth options as well from the potential to move into new regions, with the broker noting the company appears well placed to enter markets such as Gladstone and South Australia where new projects being developed will create demand for the group’s product.
One feature of the group’s contracts is their relatively defensive nature, the broker noting the company only establishes a new village if it is underpinned by a medium-term take-or-pay contract, which usually covers 60-80% of the rooms. Given it is not a contract manufacturer of the villages, but the owner-operator, the broker expects less cyclicality and contracting risk going forward.
Such an approach is capital intensive though as developing a new village requires a large amount of capital expenditure, which in turnis likely to limit the potential return on equity in the broker’s view to something between 17-20%. Any cutbacks to mining volumes such as have been experienced over the past year are also a threat to earnings, while the broker also sees scope for competition in the sector to increase over time.
Factoring all this in, the broker expects earnings growth of around 3% this year, its EPS forecasts calling for 14.7c this year, 16.9c in FY11 and 19.1c in FY12. This would put the stock on a FY11 earnings multiple of around 13x, which is reasonable value compared to the average multiple for the Australian market at present. Expected dividends of 9.35c in FY11 imply a yield of 4.2%.
The broker is not the only one in the market to take a positive view on the stock as the FNArena database shows the stock is rated as Buy four times and Accumulate once. While there has been little in the way of broker updates since the company’s full year profit result in August, JP Morgan at the time suggested earnings risk was to the upside given the resiliency of the business model and the potential for improved conditions, which largely fits with the Credit Suisse analysis.
Average EPS estimates according to the database stand at 15c in FY10 and 16.5c in FY11, broadly in line with Credit Suisse’s numbers. The average price target is $2.18, but this reflects dated targets from the likes of JP Morgan and UBS that are now below the current share price.
Shares in The Mac Services Group today are slightly higher and as at 10.55am the stock was up 1c at $2.24. This compares to a range over the past year of $0.74 to $2.32.