Imdex’s Operational Leverage Attracts

Small Caps | Jun 06 2024

This story features IMDEX LIMITED. For more info SHARE ANALYSIS: IMD

A lack of junior miner exploration in tough economic times has weighed on drill supplier Imdex, but brokers believe an upswing is not too far off.

-Junior miner spending has been restricted recently
-Rising commodity prices suggest momentum may change
-Imdex exhibits strong operating leverage
-Brokers are confident of better times ahead

By Greg Peel

Imdex ((IMD)) is the leading global supplier of intelligent drill rig tools, drilling fluids and software to the mining industry. The tools provide geological information about the drillhole, and fluids are used to lubricate the rig and enhance drillhole performance.

Drilling in the mining industry is all about exploration for metals/minerals. The extent of drilling activity at any time is dependent upon prevailing commodity prices, which provide the incentive for greater exploration. Imdex's earnings are 80% exposed to exploration spending.

Imdex's share price has risen from under 20c in late 2015 to $2.26 today.

In 2023, global exploration spend was US$12.6bn, down -3% year on year from US$13.1bn in 2022, Morgans notes. Standard & Poor's expects spending to be flat to down -5% in 2024.

Over one year, the price of gold has risen from under US$2000/oz to over US$2300/oz, recently peaking at over US$2400/oz. The price of copper has risen from around US$3.80/lb to around US$4.50/lb, peaking over US$5.00lb. These are but two metals. Others, such as lithium, have not fared so well. However, gold and copper typically make up some 50% and 25% of exploration spending, respectively.

The two are also inexorably linked as the major by-product of gold mining is copper and the major by-product of copper mining is gold. Morgans notes Imdex's share price tends to move in lockstep with the copper price. Over the last five years, the correlation between Imdex and the copper price is nearly 90%. Over this time, copper has increased by around 80% and Imdex shares by around 120%

But while larger and intermediate miners have been maintaining or increasing their exploration budgets in recent times, spending by junior miners has declined sharply given limited access to funding, being capital risings or debt financing. Holding back such funding has been the high interest rate environment, regulatory headwinds with respect to greenfield projects, and drill rig availability.

These headwinds have clearly weighed on Imdex.

A Trough?

Imdex's March quarter trading update in April fell short of analyst forecasts, reflective of lower drilling activity in a tough market afflicted by falling exploration budgets and reduced mining activity.

However, analysts were not put off. Macquarie suggested at the time Imdex was currently well placed to benefit from a pick-up in drilling activity driven by strong industry fundamentals. Stronger commodity prices were driving improved exploration budgets and increased junior capital raising activity. The broker maintained an Outperform rating.

UBS continued to see significant upside when the tide turned for global capex spending in the mining sector. The March quarter probably represented a cyclical low point, argued UBS, drawing some comfort from the strong rally in key commodities gold and copper.

Jarden agreed the worst of the cycle might now be in the past.

Emphasising this point, Citi noted in May the value of junior miner financings in April had surged past the US$1bn mark. While this was encouraging, Citi points to the December quarter, which represented three consecutive months of above US$1bn raisings but a subsequent absence of uptick in exploration. For Citi to turn more positive, the analysts wanted to see this momentum retained without severe volatility.

With continued support from solid commodity prices, Citi believed the environment was ripe for elevated junior raisings, but this had yet to emerge up until April.

Citi acknowledged it was too early to call it a pivot to a surge in exploration, but should this momentum in raisings continue or accelerate further, it could increase the likelihood of meaningful volume recovery for Imdex. This could present upside risk with respect to volumes across FY25.

Citi wanted to see a sustained level of elevated raisings from juniors before turning more positive, hence a Neutral rating.

This week, Morgans reported it had used trailing 12-month (TTM) junior miner equity raisings as a proxy for the health of balance sheets. TTM raisings have been troughing for some 13 months and previous cycles suggest that prolonged troughs tend to last 15-25 months. This indicates an inflection is not too far away. A prolonged trough is always followed by a material surge in raisings, Morgans notes, which translates into more exploration activity.

Operating Leverage

Imdex's operating leverage means earnings growth well exceeds revenue growth, Morgans points out. This holds true in both an upcycle and downcycle.

Morgans has drawn upon the historical relationship between gold and copper prices and exploration spend. Current commodity prices imply spending of US$16bn which is 27% above that of 2023 (US$12.6bn). Morgans' FY26 estimates assume exploration spend of US$13.3bn.

For every 5% increment of higher spending, Imdex's earnings per share increase by around 12%. If exploration spend were to reach US$16bn in FY26, assuming Imdex's share remains constant, this would see 30-50% earnings upgrades to the broker's forecasts.

In terms of valuation, Morgans notes when the exploration outlook strengthened post-2019, Imdex's PE ratio firmed to around 24x. From April 2022, Imdex shares de-rated to average around 16x as growth expectations faded with the cycle. More recently, the PE has expanded to around 20x. This is still well off peak and shouldn't be a deterrent, Morgans suggests, given the scale of potential upgrades.

Morgans has this week initiated coverage of Imdex with an Add (Buy-equivalent) rating and a $2.50 target price, which is based on 23x the broker's FY25 adjusted earnings forecast.

Five brokers monitored daily by FNArena cover Imdex. Of those, three have Buy or equivalent ratings and two have Hold. One of the Holds is Bell Potter, which has yet to comment since Imdex posted its interim result in February.

Bell Potter thus has the lowest target among the five, at $1.75. The other four have targets ranging from $2.20 to $2.50 (Morgans).

Also not updating since the result release in February, are Jarden, which maintained an Overweight rating and $2.10 target, and Canaccord Genuity, which kept a Buy rating and raised its target to $2.25 from $2.10.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArenais proud about its track record and past achievements: Ten Years On

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms