The bigger the bang, the bigger the boom: How are mining services stocks faring right now?
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Investing in small cap mining services stocks can be considered a risky move given their exposure to the never-ending commodities boom and bust cycles, but it can also be a potentially lucrative one if you catch them at the right time.
As derivatives of underlying mining activity, mining service providers are leveraged to their clients’ production volumes (ore hauled) and activity (exploration or development).
However, while mining companies tend to both bear the brunt when commodity prices soften and capture the margins when they go through the roof, services plays are insulated to some extent as mines will continue to roil the dirt when commodity prices drop.
While the long-term thematic for the mining sector is believed to be a positive one on the back of the global decarbonisation thrust, Argonaut’s Ian Christie believes there are several reasons why mining services stocks hold a few advantages.
“The overall investment risk is lower for the mining services companies and there’s a number of reasons for that – firstly, mining companies tend to have less control over pricing,” he says.
“Miners can’t control the whims of the world economy that shifts currencies and commodity prices, but if you’re a mining services company in a long-term contract, the ‘rise and fall’ clauses are laid out.”
These ‘rise and fall’ clauses protect business to a degree from cost increases, by rebasing margin according to fluctuating costs in the price of labour, materials, or any other nominated factor.
“And if you’re a mining services company in a short-term contract that lasts a couple of months, the price can be re-rated when your next contract comes around,” Christie continues.
Another advantage is diversification.
Mining companies are often constrained by a single commodity, mine or jurisdiction risk as compared to a mining services provider exposed to a range of commodities, geographies and sometimes even different markets – like the civil sector – through several different contracts.
Data out of independent resource industry firm Austex Resources shows Australia’s mining industry is experiencing similar conditions to the boom of 2010, with record-breaking capital expenditure and capital raisings.
Exploration expenditure across 5B reports hit $974 million in the fourth quarter of 2021 – almost double the exploration spending in the same period a year earlier – and $826 million in the first quarter of 2022.
At the same time, total capital raisings also broke a record in the fourth quarter of 2021, increasing more than 70% to $3.17 billion compared to 2020.
While activity may have slowed since the December 2021 quarter, explorers remain cashed up for the future with latest research from business advisory firm BDO showing financing inflow per explorer still exceeds historical averages and is up 11.4% compared to the average since the March 2017 quarter.
Around 87 companies reported cash balances of $1 million in the March 2022 quarter, another significant increase from the 69% average witnessed during the March quarter five years earlier.
“The last time we had a real mining boom was just over a decade ago and the key commodities there were iron ore, predominantly, and also energy,” Christie explains.
“But if we look at what is taking shape now – it is much broader, there’s a much larger commodity suite at play and this is mainly due to the decarbonisation push for lithium, nickel, copper, graphite, and everything that goes into reducing emissions whether that be through batteries, solar, wind farms or electric vehicles.
“We need far more mining, not less, to support this whole move to zero-carbon and probably a lot more than everyone anticipates,” he says.
“The reality is that it’s going to be very difficult to ramp-up supplies sufficiently to meet the goals that have been set out.”
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Capital intensive mining services businesses like Perenti Global (ASX:PRN), Macmahon Group (ASX:MAH), NRW Holdings (ASX:NRW), and Maca (ASX:MLD) averaged around 85% in free cash flow conversion during FY21/22, which Christie says “is pretty high”.
“This means these businesses were able to convert their earnings into cash coming through the door. We felt that solid operating cash flow was a key takeaway from the last reporting season.
“A second highlight was margins. If you think back to the beginning of the year when we were in lockdown and everyone was so worried about labour, costs and inflation, people were expecting to see the margins of mining services deteriorate,” he explains.
“But that didn’t happen – they came down slightly, but probably far less than was originally expected.
“Meanwhile, revenue grew by an average of 30 per cent between FY21 and FY22 across a broad range of services businesses.”
Dynamic Group (ASX:DDB) has been providing drill and blast services to major mining companies like Rio Tinto, FMG, Main Roads, Galaxy Resources, Newmont and Atlas Iron since incorporation back in 2011.
The company increased its FY 2022 revenue by 218% to $74.1 million from the previous corresponding period, leading to EBIDTA of $17.1 million, up 240% and NPAT of $9.2 million – up another 381%.
With a fleet of 47 drill rigs and 300+ personnel servicing 17 active projects across a broad mix of commodities, DDB managing non-executive chairman Garret Dixon says the outlook for the business is very strong – especially after acquiring drilling company Orlando Drilling, which contributed to DDB’s growth.
“The markets we are operating in have experienced strong growth, and we see ongoing solid demand for all commodities.
“We now have an integrated offering across water drilling, exploration drilling and production drilling so we are well placed to leverage the buoyant market conditions.”
Another stock to keep an eye on is WestStar Industrial (ASX:WSI) with experience in structural mechanical and piping (SMP) and electrical instrumentation (E&I) works.
Its engineering contracting business, Alltype Engineering, has recently been awarded a new major contract valued at roughly $33 million by Lynas Rare Earths (ASX:LYC) for the SMP and E&I fabrication at its processing facility in Kalgoorlie.
The contract brings Westar’s FY2023 consolidated group contracted revenue to ~$120 million.
At Stockhead we tell it like it is. While Dynamic Drill and Blast is a Stockhead advertiser, it did not sponsor this article.