PORTFOLIO POINT: Its share price took a hammering during the GFC, and now with earnings recovering Swick Mining Services is looking attractive.
The small-cap mining services provider Swick Mining Services is enjoying a strong revival in its fortunes. The OC Funds Management investment team has met with Swick’s management team many times since Swick listed on the ASX late in 2006. The most recent meeting with managing director Kent Swick was in December, and for the first time in several years we left enthusiastic about the WA-based driller’s prospects for the next 12 to 18 months.
Swick’s clients include some of the biggest names in the resources universe, including tier-one mining giants Newmont, Barrick, BHP Billiton, Rio Tinto and Vale. It provides drilling rigs in Australia (90% of revenues) and North America (10% and growing) and has a favourable mineral skew toward the booming gold sector (more than 60% of revenues) and the essential industrial metal, copper (more than 20%).
Like many mining services businesses, Swick was caught out in the GFC with too much debt and not enough work to keep its fleet of drilling rigs and operators utilised at profitable levels. Swick went into survival mode and focused on reducing its debt burden, aggressively controlling costs and keeping its rigs in the field. It was forced to slash its drilling prices in the process. With margins and rig utilisation crunched, its share price took a hammering, crumbling through support levels above $1 to settle at the current price around 34¢.
At these levels, we believe Swick has some attractive attributes. We estimate the business could earn as much as 4.5¢ per share in 2012 and up to 6.5¢ in 2013, putting the stock on the extremely undemanding price/earnings multiples of 7.6x and 5.3x respectively. With debt levels also very low, we expect the company to start paying a dividend in the near term.
So what are some of the key factors in Swick’s earnings recovery? From our discussions with management, and our broader market observations, we are seeing several key factors working in Swick’s favour:
- Rig utilisation. Management was aiming for its fleet of more than 65 drill rigs to be 90% utilised by the end of calendar 2011. This utilisation rate is back at pre GFC levels and is about as high as can be expected given a certain portion of the fleet will be periodically down for maintenance or between contracts.
- Average revenue per operating rig (ARPOR). Again management is aiming for above pre-GFC levels of ARPOR at about $200,000 per rig month. This will be driven by ever-improving rates (the price Swick charges for its drilling services) and productivity (the number of metres Swick’s rigs drill per shift).
- Order book. Swick continues to win contracts in Australia and North America and its order book currently stands at about $200 million, with about 95% of its forecast 2012 revenue of $130 million already contracted. Add further anticipated contract wins to this order book, with tendering levels very high at present, and Swick’s top-line growth for 2013 and beyond looks robust.
- Debt reduction. Swick’s net debt to equity ratio at 30 June 2011 was conservative at below 10%. This was achieved after a concerted effort over the past couple of years funnelling most free cash flow into debt reduction and the sale of its non-core surface drilling operation for $17 million in mid-2011.
- Peers. Swick’s nearest peers are the much larger international drillers Major Drilling, Atlas Copco and Layne Christiansen, and its domestic comparable, Boart Longyear. Each of these businesses reports regular market updates and the read-through for the sector is positive, reinforcing our views particularly around rig utilisation and pricing.
- Resources. With gold prices continuing to hover near recent record levels, and copper enjoying a recent resurgence in Chinese demand, the outlook for Swick’s two primary mineral exposures is encouraging.
Add to this Swick’s enviable safety record and its market-leading innovative drilling rig development, and we believe the business is well placed over the coming six to 12 months. Upcoming catalysts investors should look out for include its interim results in mid-February and any further market updates or contract wins.
Robert Calnon is portfolio manager at OC Funds Management.