The Speculator

PORTFOLIO POINT: Hughes Drilling is an undervalued mining services company with recession-proof qualities that could drive a re-rating of its share price.

Hughes Drilling (HDX) has been listed on the Australian Stock Exchange for a bare four months after the reverse takeover completed in May of the listed shell of Everyday Mining Services Ltd (EDMS), a company that was in some managerial and financial strife.

Hughes Drilling has come a long way since its founder Bob Hughes, his wife Leanne and three daughters camped in a caravan in 1991 after winning their first contract on the development site of the Wilson Bay Marina, near Yeppoon, Queensland.

Today, the merged group operates 41 rigs for open pit coal mining operations in Queensland and NSW.

Hughes legitimately claims to be the largest provider of blast-hole drilling services to the Australian coal mining industry. 

The company is barely involved in exploration drilling of potential coal or minerals discoveries – the first activity to see cancellations of contracts in any cyclical downturn in funding for expansionary programs.

Its rigs are solely devoted to blast-hole drilling on proven resources to be extracted to meet contracted shipping requirements. It’s judged to be the Australian market leader with 35-40% of production/blast hole drilling, with its closest competitor being the private family-owned Coldwell Drilling at about half the size.

The Speculator was fortunate enough to run into Hughes managing director Andrew Drake and the financial tactician Josh Rogers, who helped engineer the backdoor listing, having a beer at Sydney’s Tattersall’s Club this week.

The merger was completed in May through the transfer of the privately-owned Hughes Drilling Pty Ltd to EDMS and an issue of 721.7 million EDMS shares plus a potential 360.8 performance shares to Hughes shareholders, which now represent 64% of the merged company under its new name of Hughes Drilling Ltd (HDX). (The conversion of performance shares is not expected to exceed more than a few million based on 2012 full-year profit-before-tax guidance from Hughes of around $7.9 million.)

Founder Bob Hughes (56) remains an executive director. His family interests retain 57.8% of the expanded company and, we can guess, at some time in the future at least part of that holding may become available to engineer further corporate expansion, or to attract a bidder at the right price.

Other founders and directors hold 16.8%, among whom include Andrew Drake, who for 16 years held a senior management  role in Queensland with international explosives maker Dyno Nobel, and later rival Orica. For the past seven years ahead of the merger he was on the board of Hughes Drilling.

Other directors are non-executive chairman Robert Hackett, and non-executive directors Geoff Bruce and Craig Burton.

Last week, Hughes Drilling saw 2.7 million shares traded, up from a week’s low of 3.6c to a high and close of 3.8c a share. At that price I snapped up 100,000 for the portfolio while also lifting my debt to the bank.

With present issued shares totalling 1,136.7 million, the company at 3.8c a share carries a market capitalisation of $43.2 million with net debt of about $20 million and net cash of $1 million.

Hughes’ operating rigs have an average age of 3.5 years and a typical effective life of 11-14 years. Practically all of its rigs are sourced from Reichdrill of Pennsylvania under a $33 million facility from Westpac, for which the company repays the balance over 48 months out of its cash flow from such major customers as Leighton, Thiess, Downer EDI, Peabody and BHP Billiton Mitsui. 

So, with depreciation at 15%, Hughes repays the rigs over 6.6 years with a total life expectancy of 12-14 years.

Reichdrill rigs typically cost between $2-3 million, with Hughes’ rig hire generating around $100,000 a month. Because it is such a major customer, Hughes holds the exclusive franchise to distribute Reichdrill rigs in this country. The company claims that enables it to deliver rigs to customers within about three months of the order, compared to as much  as 12 months for rival rigs.

In the current 2012-13 year, Hughes has a schedule for 10 rigs to be delivered to Australia. One has arrived, another five are expected by Christmas, and another four during the second half of the financial year.

All are booked up for work. Most are contracted out for five years with two-year options.