Bradken: Result 2015

Maligned mining services business Bradken revealed another weak result and repeated an all-too-familiar refrain: industry conditions remains dire, work is hard to find and there are few signs of improvement.

Even accounting for weak conditions, the company's full year result was poor. Revenue fell 15% to $968m, a little lower than we had expected, and earnings before interest, tax, depreciation and amortisation (EBITDA) was 19% lower at $136m. Underlying net profit plummeted 38% to $34m and, with net debt of almost $400m, no dividend was declared.

Impairments again featured with over $250m of assets written off. This mostly came from Bradken's equity stake in smaller peer Austin Engineering, from impairments to intangibles and from asset write downs in its wagon business, which has faced the brunt of the downturn.

Two businesses

Although the aggregate result holds little joy for investors, a deeper dive reveals that Bradken is behaving like two businesses. One business – the consumables business with about $800m in sales – continues to generate steady revenue although margins have slipped a little. This business is delivering weak rather than dire results.

Dire is almost an understatement for what has happened to the capital goods businesses which produce buckets, crawlers and rail wagons. Here, revenues have fallen violently as miners cut expenditure and seek to save cash. Sales of rail wagons, for example, have fallen by 74% since 2012; crawler and bucket sales are down almost 60%.

Almost all of the revenue decline over the past three years – a period in which revenue has fallen by a third – can be attributed to disintegrating capital goods orders. Total revenues today largely reflect consumables sales which have proved resilient in the downturn so the sales collapse may have bottomed.

Steady margins

That is important because falling revenues have been more damaging than falling margins. Year on year, for example, EBITDA margins slipped to 14% from 15%. That relatively small fall reflects the structure of Bradken's manufacturing base which can operate at utilisation rates of between 20-100% with no change to unit costs.

Falls in revenue, even if they are large, can be matched by lower costs to maintain margins, a feature that should make Bradken more resilient than its peers.

Debt, however, remains a concern. At $400m, it is far too high. The business has already extended its covenant terms, raised funds and sold assets to lower debt. US dollar denominated debt, which increases the debt burden in local currency terms as the Australian dollar depreciates, has fallen from US$235m to US$54m and free cash flow is being deployed to further lower debt but its sheer size increases risk.

Two other major risks, both related, remain. The first is cash flow which did not met our expectations, partly because of high inventory levels and partly because miners are demanding more generous payment terms. This could eventually result in lower margins as miners look to their suppliers for savings. Bradken has done well to hold margins relatively steady so far. That will have to continue for the investment case to work and we will be watching cash flow and margins carefully.

There are positives too; the growing US economy should aid the engineered products division which has 30% of the US market for large steel castings and the business is winning work with military and industrial customers. Strong sales in the US should translate to higher revenue in local currency terms, too. 

Still cheap

A potential merger with Magotteaux, currently in discussion (see Bradken's new deal) would also make strategic sense, adding a world leader in grinding media to existing sales of mill liners and crushing equipment. There remains uncertainty about this outcome, especially about price and funding implications.

The market appears to think a capital raising is imminent and there is a risk of that but, with the business trading at an EV/EBITDA multiple of just 4 times and at just 60% of its tangible asset value, Bradken is cheap enough for a 1% position in a risk tolerant portfolio. The scary level of debt and skimpy cash flow have forced a cut to our recommendation guide but, even with warts, the business is cheap. SPECULATIVE BUY.