Treasure Chest: Set For the Mining Services Surge

This story features DOWNER EDI LIMITED, and other companies. For more info SHARE ANALYSIS: DOW

By Greg Peel

What?

RBS Australia recommends buying selected Australian listed mining services companies in FY12 when earnings result are unlikely to beat forecasts and thus will provide for attractive entry levels.

Why?

RBS Australia's equity strategists and energy and transport sector analysts have been researching expected energy demand out of Asia through to 2025. The conclusion is that there will be no lack of work contracts available for Australian listed service providers to the local mining and energy industries. Where there will be a problem, however, will be in availability of appropriate labour.

The team has thus assessed which of the many planned projects are most likely to succeed and looking at tier one expansion projects, RBS prefers those exposed to iron ore, coal and energy. It's a matter of both size and confidence in end-demand.

It is not unusual for delays to occur in the awarding of contracts to those companies servicing said industries, and when the global macroeconomic climate is uncertain delays are even more inevitable. On that basis, RBS is not expecting services companies to achieve FY12 earnings results that exceed current forecasts. However, the analysts do believe that by the second half of FY12, the services sector will begin to move towards peak activity. This suggests that earnings should really start lifting in FY13-14. On that basis the RBS “alpha” analysts recommend investors look to get set in selected names during FY12.

[The asset valuation model separates two forms of upside/downside risk for a stock, called “alpha” and “beta”. Beta risk is the risk any stock carries with respect to the market in general, and varies in degree. Cyclicals, for example are “high beta”, defensives “low beta”, and some stocks even show a negative beta (bankruptcy administrators might be an example). Alpha risk is that risk peculiar to a specific stock, and thus explains movements in stock price that bear no relationship to the market in general. In this case RBS is looking at alpha opportunity with respect to the mining services sector as a whole.]

In terms of which stocks to choose, RBS believes Downer-EDI ((DOW)) is materially undervalued and should see its own alpha risks ease off over the next six months. Lend Lease ((LLC)) is offering significant earnings growth via its Valemus acquisition and exposure to the construction environment. WorleyParsons ((WOR)) is a bit overvalued at present given optimistic earnings expectations, but RBS would buy under $24.

Monadelphous ((MND)) is the best single name exposure in terms of benefitting from resource sector capital expenditure, RBS believes. Now that Mona has been promoted to the ASX 100, the stock may suffer some price weakness which would provide a great buying opportunity.

[Seems counterintuitive, I know. However promotion to the Top 100 implies MND is now a “large cap” and no longer a “small cap”. This means all those small cap funds managers (who incidentally have been doing very nicely out of Mona, thank you) must now mandatorily exit the stock.]

Speaking of small caps, in this space RBS prefers Bradken ((BKN)) given its exposure to coal and capital goods manufacturing.

Note that RBS's alpha report follows several sector reports by other stockbrokerages in the past weeks, as reported in earlier FNArena stories. Investors interested in the theme can also have a look at the following (among others):

– Your Editor On Switzer (broadcast from Nov 3) with specific mentionings for Monadelphous ((MND)) and Campbell Bros ((CPB))

– Icarus Signal Daily Update, November 8 

– Icarus Signal Daily Update, November 7

– Icarus Signal Daily Update, November 1

– Fleetwood Update Confirms Good News Story, October 12

– Top Picks In Engineering And Contracting, September 8

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