What a difference a year makes. At the start of the year, what remains of our mining services mini portfolio (see Time to buy mining services?) appeared irredeemable.
Bradken, mired in debt and rejected by no less than four suitors, languished at just 40 cents per share; Ausdrill, also debt heavy and struggling to put its fleet of drill rigs to work, fell below 30 cents. Only Macmahon, recapitalised thanks to asset sales and restructured, appeared certain to survive.
Just nine months on, Bradken’s share price has leapt five times and Ausdrill's almost six times.
Worst appears over
Debt in some companies remains high
The entire sector, especially the debt heavy, asset heavy minnows in our mix, has lifted as excess capacity is cleared and miners again open their wallets. The gold miners, in particular, have saved the day, buoyed by record gold margins.
Well, that is perhaps a bit strong. The sector in aggregate, and our mini portfolio specifically, remains in the red (not helped by recognising losses on Emeco and NRW). But death no longer stalks these businesses.
Bradken, Ausdrill and Macmahon reported mixed results that simultaneously excite and frighten.
Ausdrill’s full-year result was one of the best of the season. Although revenue rose only marginally, net profit rocketed 10 times compared to last year’s disastrous outcome; although it looked good on paper this result was built on failures of the past as much as operating improvements.
Lower costs helped lift earnings before interest, tax, depreciation and amortisation (EBITDA) margins to 16% and falling debt lowered interest costs. These were necessary changes that contributed to the better outcome.
Just as important, however, was the impact of several years of impairments and asset sales that have savaged the value of balance sheet assets by 40% over three years. One of the upsides from a shrinking asset base is lower depreciation, which is now half the sum reported three years ago. This helped lift profits as much as operational improvements did.
To be fair, free cash flow was also strong. Operating cash flow actually fell 20% reflecting asset sales over the year, but capital expenditure was slashed by 60% to just $12m. That meant Ausdrill generated free cash flow of almost $80m which was, in addition to $50m received from asset sales, put to work lowering debt.
Debt has now fallen from a peak of $460m in 2013 to $215m. With interest cover of just over 3 times, it is still far too high but repayments aren’t due until 2019 and, if cash flow of this scale continues, Ausdrill is likely to be in the clear.
Booming gold margins have lifted revenue, especially in Ausdrill's African unit which generated almost all its profit, but the huge improvement in the share price is the market’s reward for no longer being in imminent danger of going broke.
On an enterprise value to EBITDA ratio of just over five times, Ausdrill still looks cheap. It also now trades at a small discount to net tangible asset value and those who have managed to stay the course have done reasonably well. There is no better illustration of the difficulties, perils and profits of distressed investing. We don’t recommend it often.
Even though it looks cheap, Ausdrill is still vulnerable to industry deterioration. It is better but not quite fixed. HOLD.
Bradken’s result was decent simply because the market's worst fears were not realised. A business that supplies both capital and consumable goods to the mining industry, Bradken’s revenues have collapsed from $1.5bn in 2012 to just $819m last year as capital goods orders disappeared.
Although revenue declined 15% over the full year, it actually grew slightly in the second half, suggesting a turnaround. Underlying EBITDA, down 20% to $108m, still implies stable margins of 13%.
Net profit was unsurprisingly weak and 13% lower than last year but there was an improvement in the second half of the year, when the business generated $22m in net profits.
Two figures stood out: free cash flow, at $60m, was 57% higher than last year and net debt fell 11% to $352m. That is still a big number and, while the bulk of that debt is due in 2018 and 2019, Bradken isn’t out of the woods yet.
Asset sales worth $17m helped lower debt but a refinancing or capital raising is still needed to bring the balance sheet back from the brink. A major restructure should simplify the business to create two broad product groups: consumables and steel castings.
Restructuring has made for messy accounts but asset impairments of about $400m over the past two years should lower future depreciation charges and costs have been slashed by moving production to lower-cost foundries. Capital expenditure, almost $50m last year, fell to just $20m and helped free cash flow generation.
It has been a painful journey but things appear to be on the mend. Yet Bradken’s share price reflects the improvements and there is no longer a buying opportunity. HOLD.
What was originally one of the scariest stocks in our mini portfolio has turned out to be the most boring. Selling its Mongolian division for an unbelievable sum has repaired Macmahon’s balance sheet and the business has shrunk to reflect lower expected revenues.
The result, which we had expected to be a decent one, was one of the disappointments of the season.
Comparisons with prior periods are misleading as Macmahon has drastically shrunk its workforce and asset base. Over the past three years, for example, net property plant and equipment has fallen by over 70% and total assets are just a third of what they were in 2013. The workforce has fallen 60% over the same time.
Naturally, revenues and profits have suffered with revenue halving over the year. EBITDA margins have also fallen and the business generated profit of just over $1m.
The stock appears to be appalling value on a multiple of 125 times earnings. That is also misleading. Excluding a small impairment, underlying profits came to $3m and were affected by contract completions and security problems in the Nigerian business. New contract work is yet to contribute to earnings while high African costs should not be recurring although there is a risk the business might exit Nigeria altogether.
The worst part of the result was weak cash flow. Operating cash flow of just $9m was lousy against EBITDA of $39m and, with capital expenditure higher than last year despite a smaller asset base, free cash flow was in the red. There are two problems: Macmahon has been slow to collect cash from clients and new contract wins have required higher capital expenditure. We’ll be watching this figure closely.
The balance sheet is among the strongest in the sector with $57m in net cash compared to a market capitalisation of just $130m. Macmahon appears remarkably cheap on an asset basis (0.6x NTA) and enterprise value to EBITDA basis (EV/EBITDA of 3). The lack of free cash flow is an annoyance but the net cash position does provide some protection.
Despite the cheapness, this isn’t a sector to be bought by conservative investors. Some may choose to look again at Macmahon but, recognising the high risk and careful portfolio management needed to curate positions in this sector, we’ll decline an upgrade. HOLD.
Although we are yet to turn a profit from the space, the turnaround in the entire sector has been remarkable; a reminder that the time to buy a cyclical business is in the teeth of the downturn. Another reminder, which poor returns from our mini portfolio amply display, is that buying in tranches is best, as is exercising patience and vanquishing panic.
Disclosure: The author owns shares in Macmahon.