Three small caps cooking with gas

Small cap resources stocks have been hammered … but not companies servicing the oil and gas sector.

Summary: The oil and gas sector has fuelled the operations of a number of small cap resource services companies. Mermaid Marine, Clough and Miclyn Express Offshore all achieved above-market returns in 2012.

Key take-out:  Strong global demand for energy buffered the oil and gas space from the larger resources sector storm.

Key beneficiaries: General investors. Category: Growth.

As a specialist small-mid cap industrials investor, I typically have no resources companies in the portfolio.

Accordingly, I often look to resource services companies as a proxy when I feel the need to gain some indirect exposure to the resources sector. However, it’s fair to say that many of the more traditional resource services businesses have experienced a near perfect storm of volatility over the past few years.

A range of factors have been at play, giving investors a white-knuckle ride on the roller coaster that has been the resources (and related services) market.

Firstly, there was the Gillard Government’s ill-conceived Mineral Resource Rent Tax, which began to shake the confidence of investors since its conception in mid-2010. Interestingly, it has been in operation for a little more than six months now and estimates of tax collections under this regime are approximately $2 billion below expectations. Rightly or wrongly, international investors now perceive Australia to have a level of political risk on a par with some small African nations.

Then there were concerns around China’s slowing rate of growth – currently about 7% (vis-a-vis world growth rates at below 3%). The impact of this was to put the brakes on bulk commodity pricing, which some in the market had assumed would be propped up by Chinese demand for at least the next decade. The prices of key steelmaking products – coking coal and iron ore – slumped by more than half. The perception of a slowdown in China had a commensurate flow-on impact on base metals, with prices tanking there as well.

Perhaps the above was best illustrated by the drastic action taken by former market darling, Fortescue Metals Group, in announcing late last year the dramatic scaling back of its expansion activities and its ambitious production targets. Fortescue’s share price effectively halved from top to bottom in the space of about five  months during 2012.

Inevitably, the flow-on impact for resource services stocks played out. Dirt movers where dumped – NRW, with its exposure to iron ore in WA and coal in Queensland, was thumped from above $4 in March 2012 to below $1.50 in December. Drillers were also driven into the ground – global drill services provider, Boart Longyear, was likewise belted from above $4 in March 2012 to below $1.50 in December. Even white collar service providers were put through the wringer. Global engineer and project management business, Ausenco, saw its share price halve from its highs above $4 at the beginning of 2012. Whilst these names, and many of their peers, have begun the long road to recovery, most investors (and their heart surgeons) would have preferred to avoid the tumult.

So where have I found a safe harbour in which to shelter from the resource service storm? It may seem counter intuitive, but a good place to start was a subsector of resource services itself, being the offshore oil and gas service providers. The oil and gas space was buffered from the larger resources sector storm and, in fact, the three stocks mentioned below all recorded solid gains for calendar year 2012.

The reasons for this performance divergence are myriad but I believe come down to a few key factors. The global oil and gas market operates largely independently of China. Whilst China is the world’s largest consumer of iron ore and coking coal, the price of oil (and the fortunes of oil producers and their services companies) is not dependent on the current perception of China’s economic health. Projects, like those on the North-West Shelf off the coast of WA require enormous amounts of capital and decades of commitment. The decision making in relation to these projects is driven by global oil majors such as BP, Chevron, Shell and Australia’s Woodside, who take a long-term view of the world’s energy needs. In short, the oil and gas space is less prone to violent swings in sentiment than those with a highly concentrated customer base (such as iron ore and coking coal).

Mermaid Marine (ASX: MRM)

Up 20.1% in 2012, MRM has upwards of three dozen vessels of various capabilities providing specialist support services to all phases of the oil and gas development cycle (including exploration, construction and production), with a focus on North-West Shelf projects. Additionally, MRM operates two highly strategic supply bases in Dampier (currently supporting the massive Gorgon LNG project) and Broome. MRM has a blue-chip register of small cap investors and an A-grade management team. It is currently trading on 15x FY13 consensus earnings.

Clough (ASX: CLO)

Up 34.8% in 2012, CLO provides engineering, construction and operational support services to global oil majors including Chevron, INPEX, Total, BP, ExxonMobil and local players such as BHP, Woodside, Oil Search and Santos. With a focus on Australian-based operations, (but it also stretches up into PNG), CLO is currently trading on around 11x FY13 consensus earnings. Adding to the investment case is CLO’s 35% stake in joint venture partner and highly rated fellow listed engineer, Forge Group (FGE:ASX). The stake is currently worth almost $200 million, compared to CLO’s total market capitalisation of around $900 million.

Miclyn Express Offshore (ASX: MIO)

Up 23.7% in 2012, Singapore-based and domiciled in Bermuda, MIO is a touch outside the square and, with a market cap of just under $700 million, is the smallest of the three stocks I like in the space. MIO provides charter vessels to service offshore oil and gas clients in South-East Asia, the Middle East and Australia. The register is primed for takeover, with private equity groups Headland Capital Partners and CHAMP each holding a 30% stake in the business. The management team is led by industry veteran Diederik de Boer and the company is trading on a relatively undemanding 10x FY13 consensus earnings.

Source: Bloomberg


Robert Calnon is portfolio manager at OC Funds Management Limited.

Graph for Three small caps cooking with gas
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