Boart Longyear's dirty thirty-five

It isn’t new that the mining services sector is in trouble but the Boart Longyear result still has a breath-taking aspect to it.

The starkest and most startling number in the group’s June-half result was the 35 per cent slump in revenue. Compared to a year ago the group generated $US380 million less revenue. In that context it’s not surprising that it is racing to restructure its debt to avoid breaches of its financial covenants that could occur as early as December.

Losing more than a third of your revenue base within 12 months – an annualised $US760 million – has to be traumatic and produce dramatic responses. A 38 per cent reduction in head count – about 4300 positions – including a quarter of general and administrative positions, is quite dramatic.

The disconcerting and depressing thing for Boart and all the other contractors grappling with the downturn in capital and recurrent spending within the resources sector in response to China’s slowdown and the evolving supply-demand dynamics for commodities, however, is that the structural changes have yet to settle at a new level.

When Rio Tinto announced its interim result earlier this month Sam Walsh announced $US1.5 billion of cost savings and said Rio was targeting $US2 billion for the full year and then another $US1 billion in 2014 – $US5 billion in total by 2014. Capital expenditures for this year were expected to be around 20 per cent, or $US3.5 billion below last year’s (Swings and roundabouts in a Rio transition, August 8).

Last week BHP Billiton’s Andrew Mackenzie revealed his group had ripped $US2.7 billion out of its cost base in 2012-13, with an annualised run rate of about $US3 billion a year. He foreshadowed more – a lot more – to come. Capital and exploration spending was forecast to fall from $US21.7 billion to $US16 billion this year and then to $US15 billion over the next few years, even with the $US2.6 billion commitment to the Jansen potash project in Canada (BHP rides the tail of a changing China, August 20).

So, just two of the big resources groups have within a few weeks announced operating cost reductions over the next few years that would total about $US6 billion in a full year and are now carving into their future capital spending as well. Similar strategies are being pursued across the resources sector.

That's why Boart (the world’s largest supplier of drilling services and equipment) and its peers have experienced leveraged impact on their businesses, with no near-term relief in sight because the once-massive pipeline of future activity is rapidly disappearing even as the terms of continuing activity are being negotiated down.

The first costs targeted by BHP when the downturn emerged were its contractors, which either got terminated or saw their contract margins heavily reduced. In Boart’s case its EBIT margin (earnings before interest and tax to revenue) fell from 14 per cent to 1 per cent.

The relative speed at which the turnaround in once-buoyant fortunes has occurred makes it almost impossible for the contractors to cut costs or reconfigure their business models quickly enough to soften the impacts. Boart took $US70 million out of its cost base last year and another $US90 million in the latest half but that’s still less than 50 per cent of the decline in revenue.

The resources boom may be changing shape and switching from price-led growth to volume growth but the downwards structural shift in pricing and the severe focus on costs and capital retention it has forced within resource companies has certainly ended the boom for mining services companies, which are now focused on simple survival.

Boart isn’t hiding from the continuing deterioration in its markets and expects its second half to be worse than its first half (after putting to one side the largely non-cash $US315 million of impairments and restructuring charges that pushed its statutory earnings $US329 million into the red).

If it can successfully restructure its debt, which at $564 million is 51 per cent higher than it was a year ago – and it believes it can – it will have no option but to keep cutting costs in the hope that its can bring it into line with revenues which will presumably stabilise at some point, albeit at a greatly reduced level.