$12bn Mining Services value wiped: what’s your exposure?

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We have seen a total of $12 billion wiped from the value of Australian listed mining-services companies in six months as industry expansion work decreases.

The shakeout in the sector is expected to continue for at least six months:

“There have been few receiverships or distressed sales at this point, but we expect this to change in the absence of proactive consolidation and rationalisation across the sector. Some companies with lower gearing are well positioned to take advantage in this market."
Oceania Corporate Restructuring Leader, Vince Smith.

Our recent annual survey of global mining and metals companies Business Risks facing Mining and Metals 2013-2014 has seen the twin capital dilemmas of ‘capital allocation’ and ‘access to capital’ rocket to the top of the business risk list for mining and metals companies globally, up from number eight in 2012.

In this article, we explore these consequential pressures and risks facing the Australian Mining Services sector, and the implications and opportunities arising for mining operators and lenders exposed to the machinery equipment, or ‘yellow goods’ market.

Impact of falling capex on Mining Services in Australia

Mining capex in Australia fell by approximately 20% in the March quarter of 2013 and is forecast to fall a further 10-20% during FY2014. As there is a direct correlation between the level of mining capex and the revenues of mining service providers, we expect that the sector will continue to contract.

Of the 84 mining services providers listed on the ASX, 41 have issued profit downgrades in the past 6 months (48.8%). The majority of these downgrades are attributed to deteriorating market conditions.

These market conditions can broadly be attributed to the reduction in capex by mining companies (reducing growth) and seeking efficiencies via cost reductions (reducing margins). This has placed pressure on some mining service providers as contracts are either renegotiated, or exited via ‘termination for convenience’ clauses.

The actual and forecast contraction in capex - combined with mining operators focus on cost reduction - has had a negative impact on utilisation rates for plant and equipment, with a particular impact on the primary and secondary ‘yellow goods’ market.

Yellow Goods market sees lower utilisation

In the primary market, the major yellow goods distributors and dealers are reporting a large build up of stock levels as a result of a reduction in sales and cancellation of orders. Incentives are becoming increasingly common.

In the secondary market, we are seeing material falls in the resale value of yellow goods due to the volume of equipment circulating in the market. To some extent this is being exacerbated by:

  • Reduced maintenance - Cash constrained operators reducing the level of maintenance on their yellow goods.
  • Downward pressure on margins - As new contracts are relatively scarce - competition for contracts often results in downward pressure on margins. Small to medium operators are therefore being forced to downsize fleet sizes. They have suffered most from variable work levels and pressure to meet finance commitments during a time of reduced operating margins. For underutilised equipment this is creating a significant cash drain.

Implications and opportunities for mining operators and lenders

The reduction in value for yellow goods has several implications for stakeholders.

For mining operators:

  • Opportunities to acquire yellow goods from Mining Services companies - Operators may have the opportunity to acquire equipment at a significant discount compared to 12 months ago. However, operators that purchase discount equipment should ensure any acquired equipment can be immediately utilised. Acquiring equipment to hedge against equipment supply issues is no longer valid in a market where supply outstrips demand. Operators must ensure contracts are awarded before making acquisitions.
  • Opportunities to sell yellow goods as $AUD lowers - Operators seeking to sell equipment should do so sooner rather than later as the secondary market is forecast to continue to decline. Operators should consider the impact on saleability if electing not to maintain equipment servicing. Vendors needing to access global markets to dispose of surplus assets will see recoveries further reduced due to high relocation costs. On a positive note the depreciation of the $AUD will lessen this impact.
  • Adjusting the balance sheet - Operators may need to impair the value of assets held on balance sheet. This may have gearing implications and appropriate early communications with lenders should be sought.

For lenders:

  • Impact on gearing ratios - With debt in the sector at a historical high, lenders need to be aware that the value of their security may have fallen materially enough to have an impact on gearing ratios. Lenders should also satisfy themselves that assets are being appropriately maintained.
  • Ongoing need to fund debt reduction and working capital - An increase in risk levels for lenders is evident as equipment values decline. There will be an ongoing need to fund debt reduction and working capital, and consequently banks and investors’ services as the current highly leveraged structures of mining service providers are unwound.

Given the current issues facing the Mining Services sector in Australia we are likely to see consolidation across the sector as efficient operators seek to expand by acquiring less efficient operators. Evidently, we are also likely to see a reduction in yellow goods fleets as operators seek to address the imbalance between useful life (approx 10 years) and contract terms (approx 4.3 years, based on EY’s sample review of 20 recent contracts).

It is critical that mining services companies and stakeholders - including mining operators, investors and lenders to the Mining Services sector - assess and measure the opportunities and risks arising from the constrained yellow goods market immediately.

Questions to ask yourself:

  • Are you aware of your exposure to the various stages of the mining lifecycle? Understanding the complete supply chain, including key contractual terms is critical to get a complete picture of financial viability.
  • As a lender or investor to a mining services company, is the business appropriately diversified across projects and into other sectors (for example - Oil and Gas, or Civil Contracting) and if not, what is its capability to respond to other options in the event of termination?
  • Have mobilisation or re-location costs been factored into any diversification plans? These can often be significant and prohibitive.
  • Is your forecast information current and can it be substantiated? As the sector deals with this period of uncertainty and readjustment - dated forecasts, historical financial data, unsubstantiated pipelines and order books will be indicators of poor future performance.