MARKETS SPECTATOR: Mining drag

Resource companies are instituting severe cost cuts with negative implications for a host of companies that provide services to them, says Morgan Stanley.

Mining services, engineering and construction and chemical companies have yet to truly feel the latest wave of aggressive cost cutting by the biggest mining companies, making their earnings and future stock outlook gloomy, according to Morgan Stanley.

In an anonymous survey of 13 Australian metals and mining companies the broker says mining company cost cutting will be positive, though “modest”, for earnings. But material downgrades in earnings for mining services, engineering and construction and chemical companies are a distinct possibility with negative implications for the stocks, it says.

“Larger miners appear the most aggressive in their cost reduction targets, with a higher proportion of the savings viewed as permanent,” says the broker. “Virtually all cost reduction initiatives had yet to be implemented” as of February and March, adds Morgan Stanley, “meaning despite some early profit warnings from the industrials, further downside” is expected.

Morgan Stanley has an 'underweight' recommendation on Leighton. The company reiterated its net profit forecast for its fiscal year of $520 million to $600 million. The broker also has an underweight recommendation on UGL. Leighton and UGL are not buys, according to Morgan Stanley, because of “their exposure to capex, maintenance and contract mining as well as second-wave non-discretionary cutbacks affecting UGL in particular”.

Monadelphous Group and Downer EDI are also 'underweight' recommendations, according to Morgan Stanley. Monadelphous, in the broker’s view, has the greatest exposure to the deteriorating conditions in the mining industry while contract miner EDI is a cost reduction target for the mining companies.

At 12:21pm AEST Leighton shares rose 30 cents, or 1.5 per cent, to $20.23. UGL was down 3 cents, or 0.3 per cent to $9.98. Monadelphous was up 2 cents, or 0.1 per cent, to $20.82. Downer fell 14.5 cents, or 3 per cent, to $4.685.

Downer’s stock is up 29 per cent over the last 12 months. Monadelphous shares have gained 0.6 per cent, UGL’s stock is down 14 per cent and Leighton’s is up 8.8 per cent over the same period.