Outlook Dims For Engineers & Contractors

This story features ALS LIMITED, and other companies. For more info SHARE ANALYSIS: ALQ

-Activity trends weaken
-Segment selection crucial to value
-Positives in NBN, transport infra
 

By Eva Brocklehurst

Raising of equity capital among junior and mid-tier miners is a signal for their exploration partners, engineers & contractors, given exploration activity lags the capital raisings by several months.

UBS notes, globally, these miners undertook 72 capital raisings for such purposes in June. This figure is down on the prior month's total of 91, and the prior corresponding June (110).  In value terms this was a reduction of 55% on June 2014 and raisings were well below the run rate over the past six months.

That is the backdrop. After some months of stability it now appears a further leg down in the activity trend has occurred. Australian equity raisings among these miners were down 71% year on year in August. The outlook for those which service the industry appears weak.

ALS ((ALQ)) recently commented that minerals testing orders were strong enough heading into the first quarter of 2015 but have since deteriorated. Drilling services operator, Boart Longyear ((BLY)), is likely to weaken further should current trends continue, UBS maintains.

Goldman Sachs is also finding little light at the end of the tunnel. The earnings downgrade cycle continued in the engineering and contracting sector in FY15 and the broker reduces FY16-18 forecasts on increased commodity price volatility, slowing global growth and the unrelenting pressure associated with capex discipline and resources cost deflation.

There is ample evidence of lower capital investment among miners and a deferral of project sanctioning. This is consistent with the cyclical transition to exploiting resources from a period of resources investment, the broker attests.

Goldman Sachs prefers CIMIC ((CIM)), which has a Buy rating from the broker on share price weakness, given its exposure is more weighted towards the preferred domestic infrastructure segment. The company is a market leader in major Australian project work. Goldman has a Sell rating for WorleyParsons ((WOR)) and ALS, given ongoing commodity-related headwinds, particularly in the case of oil engineering for WorleyParsons.

The broker also downgrades its sector-relative rating for Seven Group Holdings ((SVW)) to Neutral from Buy. The company's outlook is heavily leveraged to depressed mining capex and oil price volatility, as well as challenges in the traditional media market.

A ray of light is proffered by Ord Minnett. The broker has been bearish for several years towards the sector but, having endured a substantial sell-off, it may now be the time to change to a bullish view, at least in terms of some of the better players in the sector.

The broker assumes the market will buy the sector once it realises most of the earnings decline has occurred, re-rating some of the stocks that trade on very low multiples. This is critical, as the broker warns there are some stocks which remain seriously challenged. Consolidation is expected to occur and good balance sheets will provide some companies with options that could be future catalysts for the stocks. 

Ord Minnett also finds signs that miners are no longer attempting to reduce contract margins, because some operators are almost at the point of going to the wall. Work levels have stabilised and the positives on the horizon include work from the NBN roll out, transport and greater outsourcing from government.

Ord Minnett singles out Mineral Resources ((MIN)), which has been sold off heavily despite its FY15 results being in line with expectations. The broker believes FY16 consensus estimates need upgrading and retains a Buy rating and $6.30 target.

Another stock is RCR Tomlinson ((RCR)), Buy rated with a $2.50 target. The company has a record order book worth $1bn, being well placed to grow its power business. Decmil ((DCG)) remains a value play, having substantial property which could be sold and, with a market cap of $167m, trading at a 32% discount to its assets, in the broker's view. Ord Minnett has a Buy rating and $1.60 target.
 

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