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Experts
MoneyTalks is Stockhead’s regular drill down into what stocks investors are looking at right now. We’ll tap our extensive list of experts to hear what’s hot, their top picks, and what they’re looking out for.
Today we hear from Merewether Capital portfolio manager and utter Novacastrian legend Luke Winchester.
“One sector that really interests me right now is mining services,” Winchester says.
“It’s one of the few sectors that performed well in 2022 and enters 2023 with strong momentum, not just with the stock prices but business momentum as well for many constituents across the sector.
“The market has been slow to come back to the sector overall after it spent years beaten down post the mining bust in 2013.
“But through the mining boom, times were exuberant for the mining services contractors as capex from mining customers spiked higher.”
Billions of dollars’ worth of investment was brought forward as commodity prices rose and the services companies reaped the rewards of all the money being spent, he adds.
“But when the boom ended and budgets were slashed, these same mining services companies did it extremely tough,” Winchester explains.
“Margins were hit hard and many who took on debt through the boom didn’t survive.”
Fast forward to today and the sector looks a lot healthier.
“The scars of the mining bust remain with balance sheets much more conservative across the sector, and management teams much more aware of fixed price contracting risk,” he says.
“Years of underinvestment from mining customers is also being rectified with elevated commodity prices leading to the confidence to invest strongly once again.”
That said, investors still need to be careful, he warns.
Mining services businesses are still inherently tough investments with characteristics that are generally undesirable; low margin, cyclical and reliant on the budgets of customers.
“But there are times they can be good investments, usually when the cycle in the sector is performing well but stock prices haven’t reacted yet, which may be the case right now.”
For disclosure, Winchester owns XRF in Merewether Capital.
XRF provide lab equipment used in the testing of mining samples.
Their products are used in the crushing and melting down of samples to be used for x-ray fluorescence (XRF) testing.
“While the business is cyclical, most of the testing is done on production rather than exploration which is where most of the cyclical capex is spent by mining customers,” Winchester says.
“They also have a razor/razorblades model whereby they sell consumable products that are used in their machines for testing.
“The consumables segment is extremely high margin (~35% profit before tax margins) and sets XRF apart from mining services peers who generally have profit margins in the low single digits.
“I estimate the business trades on ~15x FY23 earnings which is a reasonable price given the business has grown profits by 45% year to date at their AGM update.”
VYS are looking to build out a water services business across the mining space.
The earnings driver of the business is their hydrogeological drilling segment which provides de-watering services for tier-1 mining companies (BHP, Rio and Roy Hill).
As more production goes below the water table these services will become more in-demand, but the segment is at a “steady-state” with 12 rigs across 3 clients generating significant cash.
“Management is forecasting ~$12m EBITDA from the drilling segment and I estimate ~$4-5m maintenance capex required to keep the rigs up and running, leaving $7-8m free cash which management are using to make acquisitions and flesh out an integrated water services business,” Winchester explains.
“At a $42m enterprise value a free cash flow yield in the mid-teens is an attractive valuation.”
MCE is a specialist manufacturer of subsea buoyancy solutions for the offshore oil and gas sector.
Like XRF, Winchester says he is attracted to the higher margins generated by IP developed in-house around the use of composite materials.
“While historically reliant on the cyclical sector of offshore oil and gas, the emergence of deep offshore wind projects expands the opportunity set for their existing buoyancy solutions,” he says.
“The business is an example of what I referred to above during the mining bust, as they were heavily leveraged and have been forced to re-capitalise in the past.
However, with a recent capital raise the business is now well-funded to capitalise on further contract wins and return to sustained profitability in the coming years.”
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