Bargain hunters hail mining service stocks

With miners holding up well on the ASX bargains will be found in sold off mining service companies

Picture: Bloomberg

So far at least, the leading resources stocks have been a shining headlamp of hope down the dark and deep pit of the COVID-19 crisis.

The crucial iron ore sector has barely missed a beat as China’s production line whirrs and clunks again while the gold producers are enjoying record $A-denominated prices.

Thermal coal has been troublesome pricing wise, yet Queensland output continues apace despite issues with either flooding or lack of water (take your pick).

Logically, the mining service providers should be robust as well. If mines are pumping out similar or higher volumes, there’s the same need for services such as drilling /excavation, trucking/transport, metallurgical testing and labour training and hiring.

Macquarie Equities notes that the contractors’ recent quarterly updates suggested little COVID-19 impact to date, although that’s not necessarily the case with their overseas operations.

“Restrictions on movement and self distancing present challenges but they are being overcome,” the broker opines.

Macquarie also notes that of the providers that withdrew guidance because of the COVID-19 risk, they did so because of perceived risk rather than actual impact.

Rival broker Goldman Sachs has sharply upgraded earnings expectations for the contractors under its coverage, from forecasting a 12 per cent diminution for the 2019-20 year to a 2 per cent increase.

“The resilience of the sector has come in ahead of our expectations, with quarterlies pointing to limited disruptions to date across the Australian mining complex,” the firm says.

Meanwhile, the share valuations of the key mining contractors have tumbled over the odds since the share market peaked on February 21.

Shares in Downer EDI (DOW), Emeco (EHL) and diversified NRW Holdings (NWH) have fallen at least 40 per cent, while the 30 per cent diminution of value in the Seven Group (SVW) has put a $1.2 billion dent in Kerry Stokes’ personal fortune (don’t worry, there’ a lot more in the Stokes portfolio).

Worley Parsons (WOR) shares have been punished even more because of the engineering house’s over-the-odds exposure to the oil and gas sector.

Although the stock bounced in recent days on news the company had shed 5 per cent of its global workforce – some 3000 heads – since the start of the year.

Of course, investors are known for having the memory of a gnat. But for those who experienced the global financial crisis, their reticence on mining service stocks is well justified.

Why? The sector was portrayed as a defensive no-brainer during the global financial crisis and in the aftermath when commodity prices cratered.

The argument went that the handmaidens to the miners were insulated from the commodity rout because their mining clients would continue to crank out the product.

As it happened, the sprawling mining services sector was just as badly affected, if not more so. The root causes were threefold: debt, debt and more debt.

Equity holders in the world’s biggest driller, Boart Longyear (BLY) have been pretty much wiped out by the debt holders. In mid 2011 the stock traded at $1160 (in adjusted terms) but now charges hands for 70c.

Sectoral giant RCR Tomlinson (RCR) went into voluntary administration in late 2018, owing $630m. The collapse however was spurred by specific contract problems as the company expanded into large scale solar projects.

While the greybeards will recall the corporate casualties, they will also remember the remarkable value that ensued from the trashed valuations.

For example, investors who perfectly timed the recovery of GR Engineering (GNG) between mid 2013 and October 2016 would have pocketed a 318 per cent gain.

Those riding the bucking bronco of the Queensland coal focused NRW Holdings (NWH) from trough to peak would have realised a 4800 per cent gain and an early retirement.

This time around, we suspect the mining services recovery will follow the trough-to-peak recovery following the GFC, with the best prospects aligned to production rather than exploration and capital expenditure.

Judging by their most recent ASX dispatches, the mining industry ‘handmaidens’ are doing exceptionally well – but as with the GFC the fallout for both the miners and the ‘handmaidens’ may be delayed.

As with the other Handmaid’s Tale, there’s a dystopian cloud of gloom when it comes to valuations.

The Seven Group, for instance, notes “strong operating conditions” on the mining services side, which encompasses the local Caterpillar heavy equipment franchise and the Coates Hire arm. The complicating valuation aspect is that Seven Group owns 40 per cent of the under-pressure Seven West Media.

At the risk of sounding like Captain Obvious, there’s a strong case for sniffing out the players with a debt-averse balance sheet and a diversified client profile.

For instance, Downer EDI remains a sector big daddy but its business is diversified by the takeover of the Spotless catering and industrial services group.

Tim Boreham edits The New Criterion

[e-mail]