When big miners tighten belts, large contractors feel the pinch
Gina Rinehart's indignant edict imploring governments to stop treating miners like "ATMs" could just as well be aimed at the sector's mining contractors. For them, the easy cash is drying up, and at a much faster rate than expected.
Andrew Wood, the chief executive of global engineering firm WorleyParsons, said he saw the slowdown in Australian mining investment coming, but was surprised by the rapid rate of "deterioration" as the big miners pulled the pin on big projects and wind-back costs.
Wood had thought the group's diverse range of global operations would help insulate it against country-specific risk. But instead, the downturn, predominantly in Western Australia, forced the perennially solid performer built by industry veteran John Grill into a rare profit downgrade.
Similarly, UGL's long-serving chief executive Richard Leupen was among the first to call the end of the resources boom and has been rebalancing his group's portfolio of businesses towards the steadier, if less spectacular, returns of property management and maintenance services.
And while earnings from UGL's property division are expected to make up about half the group's total within a couple of years, that has not come soon enough to insulate against what Leupen described as the indefinite deferral of "$80 billion of projects" in the years ahead.
Chief among the mega projects hitting a wall is Woodside Petroleum's abandonment of its $45 billion-plus Browse LNG development at James Price Point in WA due to soaring costs.
New BHP Billiton boss Andrew Mackenzie used his first major investor presentation as chief executive this week to flag severe cuts to capital spending. He said the miner would cut capital and exploration expenditure by 18 per cent to $US18 billion for the next financial year, down from $US22 billion the year before.
Ominously for contractors banking on a recovery in mining investment, Mackenzie said BHP's spending would continue to "decline substantially" in subsequent years.
Rio Tinto is also in the middle of a belt-tightening exercise, looking to cut $5 billion in costs, including $1 billion from its exploration budget, by the end of next year.
The wave of project delays and cost-cutting has seen the share prices of the large contractors servicing the mining industry savaged, plumbing lows not seen since the financial crisis.
Shares in WorleyParsons fell as much as 15 per cent on Friday, eventually closing $2.79 or 12.5 per cent lower at $19.50.
And having long prided himself in avoiding the spectacular implosions seen at fierce rivals Leighton Holdings and Downer EDI, Leupen has now been forced to take the bitter pill of two significant profit downgrades in the space of four months. Shares in UGL slumped 17 per cent on Wednesday, and then fell a further 5 per cent the next day before a modest recovery on Friday.
Shares in smaller engineering firm Sedgman also slumped after it flashed a profit warning, while large contractors Transfield and Monadelphous have also been sold off heavily for fear that they will be the next to reveal bad news.
"What's important to note is the impact is really three-fold in the business," Wood told reporters on Friday. "It's a multiplying effect in the business when projects get cancelled or deferred.
"First of all there's the loss of income that's coming from it ... we've had to look at further restructuring and there's restructuring costs that come through.
"And then, as a result of that further restructure, we have additional floor space and overheads in the business that we have to get rid of."
The pressure contractors are now under is apparent, what is less clear is how the situation will improve.
Wood said cost pressures in WA were a big issue, but declined to use stronger language on the subject.
"The position in WA is one of creating a level of certainty and also trying to help the industry get to a point of improving productivity of the workforce," he said.
"It's probably a question best addressed to the resource companies in their own right."
The big miners, including Woodside, Rio Tinto, BHP Billiton and peak body the Minerals Council of Australia have all been vocal in their demands around improved productivity, labour measures and smoother environmental approval processes. But possibly none are as vocal as Rinehart, a Fairfax Media shareholder.
"It [the industry] needs to keep reminding Australians this - that without mining and its related industries this country has no hope of repaying our record debt without facing the problems Greece and other countries faced with over spending and consequent debt traumas," she said.
"The industry needs to keep repeating this and standing up for itself."
Frequently Asked Questions about this Article…
The article explains that major miners have pulled back on big projects and are cutting costs, which quickly reduced demand for contractor work. That rapid deterioration in mining investment — especially in Western Australia — has led to project cancellations, indefinite deferrals and profit downgrades for contractors, squeezing their income and forcing restructures.
The piece highlights several big moves: BHP Billiton said it will cut capital and exploration expenditure by 18% to US$18 billion (down from US$22 billion), Rio Tinto is targeting US$5 billion in cost savings including US$1 billion from exploration, and Woodside Petroleum abandoned its US$45+ billion Browse LNG development at James Price Point because of soaring costs.
Woodside's abandonment of the US$45 billion-plus Browse LNG development removed a major source of future work for engineering and construction contractors. The loss of such a mega-project contributes to the broader wave of project delays and cancellations that has hurt contractor revenues and led to downgrades across the sector.
Share prices of large contractors fell sharply. WorleyParsons shares dropped as much as 15% and closed about 12.5% lower at A$19.50 (a A$2.79 fall). UGL shares slumped about 17% in one session and fell a further 5% the next day before a modest recovery. Smaller contractors such as Sedgman also issued profit warnings and companies like Transfield and Monadelphous were heavily sold off.
Contractors are restructuring to cut costs, reducing overhead and excess floor space, and rebalancing business mix. For example, UGL has been shifting toward steadier property management and maintenance services (expected to make up roughly half the group's earnings in a couple of years) to reduce reliance on cyclical mining work.
The article notes cost pressures in Western Australia are a major issue. Executives called for greater certainty and improvements in workforce productivity. Big miners and industry groups have been vocal about the need for productivity improvements, labour measures and smoother environmental approvals to help the sector become more competitive.
According to WorleyParsons chief Andrew Wood, the impact is three-fold: lost income from cancelled or deferred projects, restructuring costs incurred to right-size the business, and the additional overhead and floor space that must then be eliminated. Those factors multiply the financial stress when projects are delayed or cancelled.
Key figures quoted include Andrew Wood (WorleyParsons CEO), who said he was surprised by the rapid deterioration and described the multiplying business impact; Richard Leupen (UGL CEO), who has been rebalancing UGL toward property services and warned of an indefinite deferral of about US$80 billion of projects; Andrew Mackenzie (new BHP CEO), who flagged severe cuts to capital spending; and Gina Rinehart, who criticized governments for treating miners like “ATMs” and urged the industry to stand up for itself.
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