Mining services shake-out will see winners and losers

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Wednesday 10 July 2013 — There will be winners and losers in a looming shake-out in the mining services sector, with some companies well positioned to take advantage of opportunities and emerge stronger.

Despite a slew of forecast profit downgrades from mining services businesses this year, there is more pain to come as the impact of the slowdown in mining investment reverberates through the sector, says EY Oceania Corporate Restructuring Leader Vince Smith.

Smith says there will be a shake-out in the mining services sector over the next 6-12 months as businesses adjust to the mining investment slowdown, the shift by miners from construction to production, and the increased focus on productivity.

“There have been few receiverships or distressed sales at this point, but we expect this to change in the absence of pro-active consolidation and rationalisation across the sector,” says Smith.

“Some companies with lower gearing are well positioned to take advantage in this market.”

EY analysis of listed companies on the ASX who generate a significant proportion of their revenue from mining services shows nearly half (49%) have issued profit downgrades in the past six months, with a third of these in the past three months.

The total market capitalisation of the 84 listed mining services companies has declined 16% in the period 31 December 2012 to 13 June 2013.

Smith says there will be close scrutiny of the upcoming reporting season but warns debtors and investors should look “beyond the financials”.

“The reasons behind the downgrades come as no surprise, with the most cited primary reason being deteriorating market conditions, followed by impairment of assets and deferral of projects,” he says.

“Picking winners and losers among mining services business requires looking beyond the financials.” EY Asia-Pacific Mining & Metals Transactions Leader Paul Murphy says mining services businesses which have continued to perform to expectations have done so because they have diversified businesses, strong tender and management practices, have preemptively managed costs and know how to drive mine site productivity.

Murphy says that with about a quarter of all mine contracts due for renewal this year and miners pushing hard to reduce costs, those businesses able to diversify and deliver productivity improvements will be best positioned. “The future of individual businesses in the sector – both listed and unlisted – is dependent on a range of factors beyond their forecast profit and capital position. There are growth opportunities there for the right businesses,” he says.

Murphy says key factors impacting the prospects of individual mining service businesses in the current market include: equipment and people utilisation levels; exposure to various stages of the mining lifecycle; quality of forecasts, systems and people; contract profile (margins on renewals and tenure); cost reduction options and initiatives, and; required debt and equity levels to support new strategic direction.

Mining services by numbers

  • 84 companies were identified on the ASX which generate a significant proportion of their revenue from mining services, either through equipment or non-equipment (eg labour and consumables) services.
  • The large majority of the listed players are diversified into infrastructure, utilities and commercial and government projects not directly related to mining and are therefore exposed to broader market trends.
  • The structure of the listed sector has changed little since 2011 but during this period there has been significant growth in the unlisted sector, with an estimated 300-400 sizeable unlisted mining services business.
  • In the period from 31 December 2012 to 13 June 2013, the total market capitalisation of the 84 listed mining services companies declined 16%, reflecting a weaker outlook in growth and margin for the mining services sector in response to productivity and cost control initiatives driven by producers.
  • Non-equipment and construction focused services providers have been first hit by the downturn with market cap reductions of 20% and 29% respectively. The market cap of production focused mining services companies – the majority of the index – declined 10%.

Forecast downgrades

  • 49% of ASX listed mining services companies have issued profit downgrades in the past six months, with a third of these in the past three months.
  • The downgrade profile is largely representative of the sector make-up, with no particular mining services sub-sector affected more than others.
  • The primary reason cited for downgrades was deteriorating market conditions (46%), with impairment of assets (24%) and deferral of projects (10%) cited in many cases.
  • Equipment providers are impairing assets. Given the useful lives of yellow equipment is close to 10 years, this indicates that these companies are not forecasting a significant enough recovery to counteract the current downturn.

Median EBITDA multiples

  • Mining services providers are typically trading at 6x EBITDA but this has significantly varied over time.
  • During 2011 and 2012, equipment and non-equipment mining services companies traded at similar multiples but have now diverged to 6.1x (equipment) and 3.9x (non-equipment). A key driver of this is the assumed asset backing for equipment businesses and the assumption that equipment can be utilised in other industries, but this should be questioned given softening equipment utilisation rates and a potential oversupply of equipment in the second hand market.
  • Diversified v specialised: specialised providers have traded significantly below diversified providers since 2011 but this gap has narrowed as miners turn to niche players for innovative and cost effective mining and processing solutions.

Sector debt

  • Debt levels in the sector are the highest they have ever been, with the current debt to book equity ratio close to 50%, and sector debt net of cash having almost doubled since 2006 to $11.8b.
  • The averages mask the outliers with some very strongly positioned and conservatively geared companies ready to take advantage of the near term pressure in the mining services sector.

Equipment market

  • Equipment utilisation rates are softening resulting in an easing in pricing and orders for new equipment.
  • Total debt secured over fixed assets has marginally increased in production businesses, but has significantly decreased for construction based businesses driven by a 12% increase in fixed assets since 2012 funded predominantly with cash.
  • The average contract life of a sample of 20 recently announced contracts in the mining services sector is 4.3 years (excluding any extension options). This compares to an average equipment life of 10 years for major mining equipment in the mining sector. This mismatch between contract and equipment life will result in further utilisation reductions as capex reduces.
  • The secondary equipment market is under pressure which may undermine asset backing for financing facilities.

Non-equipment market

  • Non-equipment businesses EBITDA margins have begun to fall with construction falling significantly and production also declining. The fall has been mitigated as a result of cost base flexibility as a result of the use of contractors during the capacity ramp-up in recent years.
  • Cost pressures will continue to be pushed down to the services sector which will impact margins for non-equipment businesses in the future.
  • Consumables/materials businesses are also experiencing renewed procurement cost reduction efforts by miners.
  • Cost take out measures are however being exhausted quickly by the services sector in order to remain competitive as miners move to renew large production contracts as the production capacity built out over recent years comes on line.

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