##{"id":59922,"date":"2012-05-10T14:24:21","date_gmt":"2012-05-10T04:24:21","guid":{"rendered":"http:\/\/www.fnarena.com\/index.php\/2012\/05\/10\/stalled-capex-and-the-mining-service-sector\/"},"modified":"2012-05-10T14:24:21","modified_gmt":"2012-05-10T04:24:21","slug":"stalled-capex-and-the-mining-service-sector","status":"publish","type":"post","link":"https:\/\/staging.fnarena.com\/index.php\/2012\/05\/10\/stalled-capex-and-the-mining-service-sector\/","title":{"rendered":"Stalled Capex And The Mining Service Sector"},"content":{"rendered":"

\n\t – Big miners cut capex<\/span> plans
\n\t – Decision may impact on mining services sector
\n\t – Recent sector weakness an over-reaction according to BA-ML
\n\t – Brokers update mining services sector preferences
\n\t – Citi<\/span> analysis outlook for oil and gas capex<\/strong>
\n\t <\/p>\n

\n\tBy Chris Shaw<\/p>\n

\n\tLast week both BHP<\/span> Billiton<\/span> ((BHP<\/span>)) and Rio Tinto ((RIO)) indicated future capex<\/span> plans were to come under greater scrutiny given rising capital intensity, in Australia in particular. BHP's<\/span><\/span> intention is to stage and slow down its mega projects, meaning capital will be rationed to key investment basins. This also means large acquisitions are not on the company's agenda. <\/p>\n

\n\tRio Tinto delivered a similar message, coming as a response to the continued escalation of capital and operational pressures in Australia in particular. The implication in BA-ML's view is Australian mining sector capex<\/span>, with the exception of iron ore, is now at risk. <\/p>\n

\n\tWhile this is likely to have an impact on mining services companies, given less work on offer going forward, BA-ML sees a positive for investors in the miners themselves is that free cash flow will increase. This translates into increased opportunity for additional capital management initiatives given the magnitude of existing capex<\/span> plans. <\/p>\n

\n\tFor just the two major Australian-based miners, BA-ML estimates BHP<\/span> has 22 major projects in execution with committed spend of US$27 billion, while Rio Tinto has US$20.6 billion in committed capex<\/span> remaining for 2012-2015.<\/p>\n

\n\tThe risk to the mining services sector is that FY13<\/span> proves to be peak earnings and so share prices correct further, but in BA-ML's view there has been some irrationality in the market in response to the recent comments by BHP<\/span> and Rio Tinto and share price falls have been excessive. <\/p>\n

\n\tAs an example, the largest share price falls post the comments by the miners have been felt by Monadelphous<\/span> ((MND<\/span>)) and NRW<\/span> Holdings ((NWH<\/span>)), both of which are mainly exposed to iron ore and the major miners have indicated this sector won't experience any capex<\/span> cuts.<\/p>\n

\n\tMorgan Stanley takes a more cautious view, noting while commentary from miners is a less bullish environment is developing, market expectations for mining services companies have in some cases increased.<\/p>\n

\n\tThe issue here is that expectations in some markets have been lifted despite no increases in guidance from mining companies themselves, which Morgan Stanley suggests is a reflection of the fact investment and cost inflation are making growth more expensive to come by. <\/p>\n

\n\tThis leaves the broker concerned, as the indications in terms of conditions in the mining sector becoming more difficult are not being matched by investor expectations with respect to the mining services sector.<\/p>\n

\n\tShort-term BA-ML suggests risk remains to the downside, but the share price falls that followed the remarks of BHP<\/span> and Rio Tinto have opened up an opportunity to add to the broker's top picks in the sector. For BA-ML these include Boart<\/span> Longyear<\/span> ((BLY<\/span>)), Leighton Holdings ((LEI)). Bradken<\/span> ((BKN<\/span>)), Seven West Media ((SWM<\/span>)) and Mastermyne<\/span> Group ((MYE<\/span>)). <\/p>\n

\n\tAll of these stocks are rated as Buy by BA-ML, while the broker also has Buy ratings on Emeco<\/span> Holdings ((EHL<\/span>)), Sedgeman<\/span> ((SDM<\/span>)) and Swick<\/span> Mining ((SWK<\/span>)). <\/p>\n

\n\tFalls in price have also added to the attraction of Campbell Brothers ((CPB<\/span>)), WorleyParsons<\/span> ((WOR<\/span>)) and Monadelphous<\/span>. BA-ML's analysis suggests sector multiples are now not demanding, as on an enterprise value to sales basis most stocks in the sector are trading at well below long-term averages. <\/p>\n

\n\tBA-ML rates Campbell Brothers as Neutral, along with Ausdrill<\/span> ((ASL<\/span>)) and Imdex<\/span> ((IMD<\/span>)), while Industrea<\/span> ((IDL<\/span>)) is rated as Underperform<\/span>.<\/p>\n

\n\tAt the smaller end of the sector, Moelis<\/span> suggests Mermaid Marine ((MRM<\/span>)) remains an attractive exposure to mining services, as the group's vessels division continues to benefit from ongoing buoyant conditions in the offshore oil and gas sector.<\/p>\n

\n\tWhat supports expectations conditions in offshore services will remain robust for the next several years according to Moelis<\/span> is recent Final Investment Decisions for the Wheatstone<\/span> and Ichthys<\/span> projects. There is also talk the Gorgon project is running well behind schedule, adding weight to the stronger-for-longer thesis.<\/p>\n

\n\tGiven this positive outlook Moelis<\/span> suggests recent share price weakness in Mermaid Marine is difficult to justify, making the stock a Buy at current levels. Earnings forecasts support a positive view, Moelis<\/span> forecasting earnings per share (EPS) for Mermaid Marine of 23.6c in FY12<\/span> and 27.6c in FY13<\/span>, up from the 20.3c achieved in FY11<\/span>.<\/p>\n

\n\tMoelis<\/span> has a price target on Mermaid Marine of $3.40 per share, which is broadly in line with the consensus price target according to the FNArena<\/span> database of $3.60. Among brokers in the database to cover Mermaid Marine the stock scores four Buy ratings and two Holds.<\/p>\n

\n\tElsewhere in the sector, OctaPhillip<\/span><\/span> is positive on both Zicom<\/span> ((ZGL<\/span>)) and RCR<\/span> Tomlinson ((RCR<\/span>)), rating the former a Speculative Buy and the latter a Buy. For Zicom<\/span> the attraction is an expected return to sales growth in the offshore marine division as activity in the sector ramps up, with the current year seen as the low point in the cycle.<\/p>\n

\n\tLooking forward, OctaPhillip<\/span><\/span><\/span> expects better performance from Zicom<\/span> in both FY13<\/span> and FY14<\/span>, helped by progress in start-up investments already made by the company. All three start-ups are expected to report sales in the next 12 months.<\/p>\n

\n\tA solid balance sheet is another attraction of Zicom<\/span> and supports a Spec Buy rating, as if one of the start-ups delivers OctaPhillip<\/span><\/span> notes earnings risk is to the upside. Price target for the stock is set at $0.30, down from $0.33.<\/p>\n

\n\tFor RCR<\/span> Tomlinson, OctaPhillip<\/span><\/span><\/span> notes a recent sell-down by a major holder is now largely complete, removing what has been a weight on the share price. This weakness, when combined with a record order book of $708 million and good earnings visibility through FY13<\/span> makes the stock a Buy in the view of OctaPhillip<\/span><\/span>.<\/p>\n

\n\tWhile project execution remains a key risk, RCR<\/span> Tomlinson is estimated to be trading on a FY13<\/span> earnings multiple of 7.9 times, which OctaPhillip<\/span><\/span> sees as value given it represents a significant discount to Monadelphous<\/span>, the company's closest peer.<\/p>\n

\n\tAdd in expected earnings per share growth of more than 20% in both of the next two years and OctaPhillip<\/span><\/span><\/span> is comfortable with a Buy rating. Price target stands at $2.74, up from $2.66 previously. Monadelphous<\/span> was this week upgraded to Outperform from Neutral by Macquarie given a strong earnings growth profile, a solid balance sheet and a good track record of project delivery.<\/p>\n

\n\tDowner EDI has also enjoyed upgrades in broker ratings post an investor day yesterday, as earnings guidance was reiterated and the likes of Deutsche Bank take the view previous legacy issues are now largely behind the company This should allow management to focus more closely on growth going forward.<\/p>\n

\n\tAmong the mining services companies mentioned and covered by more than one broker in the FNArena<\/span> database, Sentiment Indicator readings stand at 1.0 for NRW<\/span> Holdings, 0.9 for Boart<\/span> Longyear<\/span> and Bradken<\/span>, 0.8 for Emeco<\/span> and Ausdrill<\/span>, 0.7 for Downer EDI, Mermaid Marine and Sedgeman<\/span>, 0.5 for Seven West and Swick<\/span>, 0.3 for Imdex<\/span> 0.2 for Monadelphous<\/span> and 0.0 for Leighton, WorleyParsons<\/span> and Campbell Brothers, <\/p>\n

\n\tAfter attending a major oil and gas trade show in the US, Citi<\/span> has similarly examined the outlook for this market. The main conclusion was while the overall demand picture remains strong, there are some signs of regional weakness becoming evident. <\/p>\n

\n\tAs Citi<\/span> notes, an oil price of US$120 per barrel for Brent crude continues to support high levels of global activity and spending. This means demand for offshore rigs remains strong, while Citi<\/span> also notes there is an increasing number of rigs being built on spec, something it views as a sign of confidence in the market in general.<\/p>\n

\n\tFor specific markets, Citi<\/span> points out demand for new equipment in the North American hydraulic fracturing market is likely to be soft through at least the first half of 2013, this as activity in this market decelerates following significant new build activity in the past couple of years.<\/p>\n

\n\tShale oil and liquids drilling should continue to grow, Citi<\/span> noting this is being offset by lower dry gas exploration levels as the former requires less horsepower, meaning less demand for pressure pumping.<\/p>\n

\n\tDemand in the international fracturing market is unlikely to offset weaker US activity in the next few years according to Citi's<\/span> market contacts as there remain obstacles such as regulatory and environmental issues<\/p>\n

\n\tThis is especially the case in China, where a lack of infrastructure to transport gas and transform it into a useable product is expect to limit growth in that country's market over the next few years. <\/p>\n

\n\t
\n\tFind out why FNArena<\/span> subscribers like the service so much: "Your Feedback (Thank You)<\/a>" – Warning this story contains unashamedly positive feedback on the service provided.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"