Inside the mining services disaster

In the period since December 31, 2012, the Australian sharemarket has moved sideways to 4,665 points. But indices hide facts.

Fact one: The market was up 12% to 5,229 by mid-May 2013, and a lot of investors forgot to take a profit.

Fact two: Many commodities, including gold, copper and iron ore (and commodity-related currencies) have been hit in recent weeks. 

What I would like to draw readers’ attention to is that the companies that service Australia’s resource sector are now in a deep recession.  

• The year to June 30, 2014 is currently anticipated to be a period of consolidation, in which the achievement of any revenue growth will be challenging at best, and in most cases highly unlikely.
• Uncertainty remains regarding the rate of new project approvals in the resource and energy sector as customers reassess their capital expenditure plans and focus their attention on high-return options. 
• Project delays and a slowdown in near-term new major project approvals will significantly reduce the pipeline of opportunities in the medium term. For example, the Bureau of Resources and Energy Economics is forecasting a 75% decline in the value of project investments, from $270 billion in 2012 to $70 billion by 2017. 

Woodside Petroleum recently announced the cancellation of its proposed onshore development of the $45 billion, 12 million tonne per annum Browse Liquid Natural Gas project at James Price Point near Broome, Western Australia.

The newly appointed CEO of BHP Billiton, Andrew Mackenzie, also recently announced a 35% reduction in the company’s annual capital and exploration expenditure, from the current $22 billion to a targeted $15 billion over the medium term.  Meanwhile, Sam Walsh, Rio Tinto’s CEO, announced that Rio will be targeting $5 billion in cost savings over the next two years.  The resources super cycle appears to be over!

Most companies servicing Australia’s resource sector have announced severe declines in their outlooks.  The extent of this downturn seems to have caught the management of these companies by surprise.  And the smaller resource companies will have increasing trouble accessing capital.

Mining services crash

Looking at 10 of these companies that service the resource sector, the average share price decline so far this calendar year is 54%. That’s an average capital loss of 9% per month!

Negative comments accompanying the various ‘earnings downgrades’ include:

• “Worse trading conditions than we saw during the GFC.”
• “Further delays of major projects impacting revenues in the engineering business.”
• “Further project slippage with flow-on impacts on anticipated revenues in the second half of F’13.”
• “What we are seeing are significant project delays or cancellations that are broader than simply mining.”
• “Ongoing uncertainty in commodity markets is resulting in the delay to and deferment of a range of resources and infrastructure projects”

I am now certain that this ‘average share price decline of 54%’ will usher in further severe earnings reductions for most resource service companies in the year to June 2014 and the year to June 2015.

A logical progression would then be that this pessimism spreads to the currently indifferent eastern seaboard of Australia’s economy. And that caution has ushered in the most recent 10% decline in the Australian sharemarket, especially given many stocks looked a bit stretched from a valuation viewpoint in mid-May. 

So the sharemarket, in net terms, has gone sideways so far in 2013, while many investors may be considering the potential cheapness of resource and resource service companies. 

After selling out of resource service companies in April 2012, I will be selectively using our high cash weighting to buy high-quality industrial companies when they sell at a significant discount to their intrinsic value.

Roger Montgomery is the founder of The Montgomery Fund. To invest, visit www.montinvest.com