Boart Longyear: Result 2012

Boart Longyear’s full-year result confirmed the end of the mining boom. Revenue for the full year fell marginally to just over US$2bn, generating net profit US$68m, a 57% fall from last year largely due to the inclusion of US$68m worth of restructuring charges.

From earnings per share of 15 US cents, down 57%, a partly franked dividend of 10 US cents (ex-date unknown) was declared. Worryingly, operating cash flow fell 68% to US$64m while the company spent almost US$280 on capital expenditure.   

Boart is the world’s largest supplier of drill rigs. Although the business is notionally exposed to the supply, rather than the price, of minerals, the demand for drilling depends of the exploration budgets of miners. That, in turn, is entirely dependent on commodity prices. Boart cannot escape its fate as a cyclical business that lives and dies by the commodity cycle.

In recent times, the cycle has been particularly cruel. Although commodity prices have recovered from last year’s lows, miners have been frightened by the prospect of a bust. The largest have tightened their exploration budgets by choice, focusing on operating efficiencies to raise volumes. Smaller miners have had lower exploration budgets forced upon them.

By choice or design, the industry is spending less on exploration and the prospect for drilling intensity has deteriorated.

For Boart, this presents a problem. The company derives 75% of its revenue, and the bulk of its profits, from drilling, and the utilisation rates on rigs fell from 75% in 2011 to 69% in 2012. Utilisation rates, determined by industry exploration budgets, contribute to wildly volatile profits. Over the past five years, net profit margins have swung from -8% in 2006 to 3% last year.

A competitive, cyclical business like this one should, ideally, carry little or no debt. That hasn’t been the case historically and it isn’t the case now. Although net debt has fallen from over US$1.2bn in 2006 to US$512m today, it’s still too high, with operating cash flow covering cash interest payments a dangerously low 2.2 times.

It’s easy to assume that all the bad news in the financials is also reflected in the share price, which has fallen from highs of over $4 a year ago. The business, for example, boasts a valuation which is currently below book value. But a closer inspection of its assets suggests it's far from cheap. From assets of US$2.2bn, deferred tax assets and intangibles comprise over US$600m and inventories another US$530m.

This is, in other words, a poor quality balance sheet. To tempt us, the price would have to fall to well under tangible book value. Failing that, there is no compelling case to buy or hold. AVOID.