Going Gets Tougher For Boart Longyear

This story features BOART LONGYEAR GROUP LIMITED. For more info SHARE ANALYSIS: BLY

-Danger of covenant breach
-Risk of equity dilution
-Recovery some way off
 

By Eva Brocklehurst

Just when you thought an outlook couldn't get more disappointing, one did. Drilling services and product supplier Boart Longyear's ((BLY)) interim results disappointed brokers again on a number of fronts including margins, cash flow and guidance. A breach of debt covenants looks likely unless some quick fixes are put in place.

There was minimal net debt reduction from the May peak. That disappointed Macquarie. Three months ago the broker had been inclined to see the build-up in debt as seasonal and did not think a breach of finance covenants was on the cards. Now, these fears could being realised. 2013 earnings are expected to be at the low end of a US$116-159m range. The bottom end of this range is nearing the nadir experienced during the GFC, when earnings fell to US$111m.

The numbers tell the story. Without any debt restructure or refinancing in the coming months, the company will be in breach of its leverage covenant as at 31 December 2013. Macquarie suspects metrics are likely to worsen in 2014, given a further deterioration in earnings is implied by the weak second half run rate. Management is confident of a successful debt restructure, with a combination of refinancing the existing US$450m revolver with high-yield US debt and asset-backed loans, coupled with increased covenant flexibility. While this should remove the risk of a covenant breach, there are no guarantees it will be achieved. Net debt looks like staying uncomfortably high for another 12-18 months. On the positive side, if successful, a debt restructure in coming months would likely see the stock rebound. Macquarie has given the company the benefit of the doubt, to the extent the recommendation is downgraded to Neutral from Outperform.

There's no recovery on Credit Suisse's horizon. Hence a downgrade to Underperform from Neutral. The broker understands interest costs could be around 9.5% on the refinanced debt and agrees this is the best course of action to re-capitalise, rather than a highly dilutive equity raising. US high yield refinancing is now included in Credit Suisse's forecasts. It's just that a cyclical recovery is the key to a rebound in the stock's price and there's no evidence, yet, that a bottom in the mining industry cycle has been reached.

It's a simple description for CIMB: Deja vu. The broker notes Boart Longyear's precarious financial position looks similar to that of 2009 and it was not meant to happen again. CIMB believes shareholders face equity dilution as the capital position is repaired for a second time. There may be no escaping the cyclical nature of the company's operations, but, CIMB asserts, this is why low debt levels should be used. Net debt of US$563.8m as at 30 June 2013, coupled with weakening operating conditions, leaves the company with limited options to manage its capital position. If an equity raising can be avoided interest rates will increase significantly. As a result, debt holders will be exchanging debt for equity on highly punitive terms.

Adding further pressure, CIMB believes the mining down cycle will run at least another couple of years, consistent with previous commodity cycles. This is in contrast to the GFC, which was credit related and recovered very quickly. CIMB also downgrades to Underperform from Neutral, with a view recovery is a long way off. UBS had suspected worse was to come when FNArena last looked at the stock in May. The broker expects a refinancing of existing banking facilities to a covenant-light structure in the short term, assuming a cost of finance of 10% from 2014. Should the company be unsuccessful, current covenants could become a significant risk for investors. Whilst conditions are depressed and there is significant earnings leverage, UBS thinks the timing of a cyclical rebound remains difficult to predict. The Sell recommendation stays in place.

The company is targeting US$90m in additional cost savings and, while a positive, brokers like Macquarie think management has been slow to act and there will not be a full benefit from this until 2014. Moreover, CIMB suspects, given the very high operating leverage, if prices fall by more than 5%, earnings downgrades will follow. Citi also stays negative and rates the stock as Sell/High Risk. The deterioration in demand due to the fall in commodity prices and a focus by mining companies on cutting operating costs and improving cash flow and margins is expected to materially affect utilisation and margins in the short-medium term.

Macquarie crunches some numbers on an equity raising. A US$200m equity raising at 34c a share, a 30% discount to the current price, would dilute 2014 earnings per share forecasts by 66%. Net debt under this scenario would fall to US$315m in 2013 and gross debt to US$362m. Gross leverage falls to 3.07 times in 2013 and 4.15 times in the first half of 2014, both below the recently revised gross leverage covenant of 4.75 times. Interest cover of 3.81 times and 4.47 times, respectively, remains above the 3.0 times minimum. Based on forecasts and under this scenario, Macquarie expects the company will generate a small after-tax loss in 2014 and return to profit in 2015. Under this hypothetical equity raising scenario, the stock would be trading on a price/earnings ratio of 42 times 2015, and 12 times 2016 estimates.

On the FNArena database there's no Buy rating. It's a sea of five Sell and three Hold. The consensus target price is 48c, suggesting 3.5% upside to the last share price. This compares with a target of 70.3c ahead of the results.
 

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