Bradken: Result 2014

When a company reveals that full year profits have almost halved, you might expect the market to be disappointed. Not so with Bradken, whose share price rose 7% as it announced falling profits.

Revenue fell 14% to $1.1bn, which was enough to send underlying net profit plummeting 43% to $55m. From underlying earnings per share of 32 cents, also down 43%, a final dividend of 11 cents was declared (unfranked, ex-date 18 Aug), taking full year dividends to 26 cents, a yield of 5.1%.

Our investment case for Bradken, and for the industry in general, depends on more cash being released as activity slows. That is now happening. Capital expenditure fell 42% to $56m and, although write-offs contributed to lower taxes, free cash flow was far stronger than net profits suggest. Whereas profit fell over 40%, free cash flow fell just 18% to $99m, allowing net debt to fall by 13% to $377m. Considering industry conditions, this was an impressive result.

The mining industry is currently undergoing a capital expenditure strike and the effects are clear in Bradken’s numbers. Sales of capital products, which reflect capex spending, fell 13% while consumable products, which reflect production expenses, fell just 8%. The decline in revenues is largely to do with fewer expansion plans rather than outright production cuts. That has allowed revenues of consumable products to be fairly steady.

Two halves

That is encouraging. Unlike peers, Bradken isn’t facing collapsing revenue and an absence of work; gross margins actually rose slightly. Instead, the company is behaving as two separate businesses, with one part, consumables, displaying stable revenues and margins while another, capital products, facing dramatically lower sales. Over the past two years, sales of capital products have halved.

The company has responded by aggressively cutting costs. Several small Australian production facilities have been closed and production moved to a larger, lower cost facility in China. That factory still has idle capacity so further offshoring is likely. Doing so has allowed margins to be maintained even as revenues fall. If industry conditions improve, the company can quickly increase production at lower cost.

Capital expenditure almost halved to just $53m and cash flow has been preserved. We were surprised that almost $50m in dividends were paid. Although this is lower than last year, we would rather see the cash spent reducing debt in a difficult environment.

Slow recovery

Coal prices, in particular, remain persistently low. The company suggests thermal coal activity remains slow and expects no improvements to the current malaise. We agree. Demand for coal from China is falling and the US is exporting high quality, low cost product from the Powder River Basin. Australian production is hopelessly uncompetitive and conditions won’t improve quickly.

Metallurgical coal might be different. The company expects renewed orders for equipment as industry output recovers and it singled out copper as another candidate for growth. The optimism is in words only. By lowering costs and limiting cash outflow, management has ensured the company will outlast the downturn. Bradken has been the star of our mining services mini-portfolio, rising 50% since we recommended it in Time to buy mining services? Part 3. With the share price up 13% since Bradken downgraded to Hold on 24 Jul 14 (Hold - $4.47), we’re sticking with HOLD.