Mining services stocks have had a good year — here’s an expert view on the sector outlook

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Mining is a cyclical industry, and one sector that offers a reasonable gauge for the inevitable swings and roundabouts is mining services.

Assessing the prospects of companies that provide adjacent services such as drilling and engineering can provide useful insights for investors looking at the space more broadly.

Having crunched some numbers, Stockhead’s data team showed the ASX small-caps operating in the space have had a pretty good year.

Of the 20 stocks in the list, 15 notched up a positive 12-month return and the group as a whole posted an average gain of 30 per cent.

Coinciding with those gains, it’s been a solid year for commodities more broadly. Prices have tailed off into the end of the year but before then, iron ore rose to all-time highs while gold prices also hit record levels in Aussie dollar terms.

Offsetting those gains were sharp falls in lithium, which saw some local projects shuttered amid fears of a global supply glut.

So where does that leave the outlook for resources activity — and by extension the prospects of mining services companies — heading into next year?

Stockhead turned to our resident resources expert Peter Strachan to get his views on the sector.

Strachan noted that it’s been a tighter operating environment for most of the past decade, since capital expenditure in connection with the mining boom peaked in 2011/12.

“At the top of the cycle you can make a killing, while at the bottom of the cycle what we see is companies doing work on an open-book basis, where they charge say an 8 per cent margin and the client sees all of the costs,” he said.

Where it sits now is somewhere in the middle — commodities have held up pretty well since 2015, but discipline around capital expenditure remains and prices for specific minerals are still subject to the same cyclical swings.

There’s also two types of client strategies, hitched to either contract drilling operations with larger players, or working with explorers which are “notoriously cyclical”.

To illustrate: “The gold price has been a big winner — all of a sudden everyone’s out there drilling for gold. More recently there was a surge in drilling for nickel, while a couple of years ago it was lithium but that’s fallen away quite a bit,” Strachan said.

In that environment, clever operators manage their exposure to combine riskier jobs (with more upside) and steadier contract assignments.

He noted that two big iron ore players – Fortescue and Rio — have recently pulled the trigger on multi-billion dollar iron ore projects.

ALSO READ: Iron ore bigwig FMG picks Vysarn for its drilling services

And the outlook is also improving for large scale LNG projects, after Woodside (ASX:WPL) flagged plans to double production off the coast of WA over the next decade.

“Down the track a couple of small gold projects could come through, but it’s starting to look a bit thin on the ground,” Strachan said.

For Patrick Conway, CEO at mining services company Mader Group (ASX:MAD), the relative strength in commodities such as gold and iron ore has helped to foster improved conditions on the ground in WA. And looking ahead, he said capex is beginning to come full circle from the 2011/12 boom year.

“Underlying the increase in output is an ageing fleet, with a lot of mining equipment purchased during the last peak period of capital investment in 2011 and 2012. So we’re anticipating an uptick in the demand for mining maintenance expenditure,” Conway told Stockhead.

A mixed bag

Strachan added that the outlook for mining services was also tied to sentiment in asset markets, which tied through to capital and investment flows.

“The other thing driving services is the availability of cash for mining clients. One source of cash is profits, and the other is risk appetite in capital markets,” he said.

“If the investing environment is strong then companies can raise money and go out and drill.”

While commodities have had a pretty strong year in 2019, markets have cooled off into the end of the year. Iron ore has come back off all-time highs, while nickel — a 2019 standout tied to the electric vehicle thematic — has also reversed.

ALSO READ: Nickel volatility is still very much a thing, here’s how to make the right pick

That makes it harder for companies in the “$15m-$20m market cap” range to raise money, Strachan said.

“They might be trying to raise $1m-$1.5m, they’re not able to go out like they were a couple of years ago and raise $5m-$10m and spend that on project development or feasibility studies.”

“So I think next year’s going to be more thin on the ground for a lot of them, but those companies that are involved in contract drilling for mining operations will be OK.”

Services companies linked to the big iron ore projects and oncoming oil & gas operations should be best positioned, Strachan said.

“But along with the top line numbers, I think one thing you’ve got to watch for is the margins, which could be squeezed because there’ll be a healthy amount of competition among those companies looking for scarcer work,” he said.

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