With mining and exploration on fire, which ASX-listed drillers are showing upside?
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When mining is in the doldrums, drilling budgets are often the first expense to be guillotined.
But when the going is good, the art of discovering and growing orebodies for miners big and small can be a lucrative business.
Hard data shows Australian explorers are taking advantage of free-flowing capital markets and the incentive of near record high prices for commodities like gold, copper and iron ore to support boom time levels of exploration spending.
For years drillers were price takers who resorted to tactics like taking scrip in exploration companies to keep their rigs turning during the downturn. Now they could turn to price makers.
Drilling, and exploration drilling especially, is a pretty small space on the ASX within the broader mining services sector, but there are several companies that provide exposure to this theme.
Euroz Hartleys Perth senior analyst Gavin Allen covers drillers and other services stocks for the stockbroker and says while some drilling stocks are yet to fire in 2021, the outlook is broadly positive.
One aspect that has weighed down mining services stocks more broadly has been commentary about labour shortages, Allen said.
These concerns have been exacerbated by border restrictions during the Covid-19 pandemic, with Perenti Global (ASX: PRN) – the former Ausdrill – among the major companies to take a big hit from a labour shortage driven downgrade.
“The market struggles to differentiate between the drillers and mining services more broadly,” Allen said.
“The whole of the sector’s been under pressure. It’s a bit hard to put a finger on exactly why that is, but it does seem to stem from labour shortages and what that might mean for margins.”
“That said, the sector does tend to differentiate and it does that around this time of the year, so I think some of the stocks you’re starting to see the valuations more fundamentally reflect value.”
Allen views labour shortages as a short term challenge that can mask what are fundamentally strong market conditions.
“The labour shortage for the drillers is not so much the backpackers, it’s the access to the higher quality or more experienced drillers,” he said.
“That is something they’ve got to manage and they’re managing it today. Clearly the more productive you are the more profitable you are, and productivity is linked to the experience of the driller.
“(Investors) are looking at it as a headwind in terms of the stocks, but I don’t think they’ve quite cottoned onto the idea that despite the labor shortage these companies are operating in very strong operating conditions.
“They can grow. Notwithstanding that labor shortages are an issue, it’s just that they could probably grow more if the borders were open.”
Companies likely to stand out from the crowd are those with a good recent track record that can demonstrate “rubber on the road”, Allen said.
He highlighted SRG Global (ASX: SRG), which has a drill and blast business among its broader operations, as one that had demonstrated its rubber with a series of upgrades.
Imdex (ASX: IMD), which supplies mining and drilling-related technologies and products, is also trading at good multiples, Allen noted.
“That’s what I mean by rubber on the road,” Allen said.
“So it’s ultimately about your results, but if you can provide an outlook statement beforehand and some companies have been able to do that earlier than others, then you do get rewarded for that.”
As demand for drill rigs increases, talk about increased rates for drilling services is beginning to emerge as well.
“We’re beginning to see that and we’ve already seen that in parts,” Allen said. “And that will be part of the rubber on the road equation because that will come out in the results.
“Fairly consistently across the drillers we are hearing discussion around rig rate rises and it tends to be that if you were a really pointy end driller in terms of exploring, you are more quickly able to increase your rates as opposed to if you were a drill and blast or underground production drilling.
“All of the drillers I think are experiencing buoyant conditions at present.”
In the pure exploration space Swick (ASX:SWK) is one company that seems to be benefiting from improved trading conditions.
Last month Swick updated its 2021 forecasts to $153-156 million revenue and EBITDA of $29-31m, compared to $149.6m and $24.6m in 2020, prompting the company to renew plans to demerge its tech division Orexplore.
“So Swick is a really good example of a company that has seen those rig rate rises and is starting to get that rubber on the road,” Allen said.
“They had an update the other day which was really positive and the next step for them is the demerger, because then the investors are able to think about the drilling business in isolation, at the moment it’s a bit crowded with Orexplore in the mix.
“Swick whilst it’s had a little bit of a share price change recently, it still in no way reflects what I think is going on fundamentally.
“On the drilling business it’s still probably an EV of 2.5x.”
Diamond drilling expert DDH1 (ASX: DDH), which Euroz Hartleys initiated coverage on last month, is one stock Allen likes.
After disappointing on debut earlier in February, DDH’s share price is up to $1.16, slightly above the $1.10 issue price for its $150 million float.
Alongside a bullish market, the fact DDH listed with no debt means it can focus on generating cash flow.
“One is the idea of the mass that they had 88 rigs that were rolling and now they’ve got 101 rigs rolling in 2021,” Allen said.
“With the listing they haven’t got any debt, so investors get the benefit of the full run rate in 2022, so mathematically it’s growing in ‘22, and utilisation is assumed as steady as a consequence of the added rigs.”
“That drives an outcome to which I can find value anyway.”
“Beyond that though we are in an environment where I think we are going to see rig rate rises and it doesn’t need much in terms of a rig rate rise, or a utilisation change, both of which I think is genuinely possible, to put on some growth beyond what the market’s expecting.
“So that’s an easy one for me.”
Allen said NRW Holdings (ASX: NWH), which provides broader mining services but has drill and blast operations, was also one to watch. Shares have slid around 50% year to date and from recent highs of $3.12 in January.
“It’s been caught up in some labour shortage issues which I think the market has overreacted to,” Allen suggested.
“They have an opportunity with the full year result to more clearly explain how the overall business is travelling.”
There are a handful of smaller players around as well.
They include Dynamic Drill and Blast (ASX: DDB), which listed last August after a $5 million float and is trading at more than double its IPO price.
In recent months we’ve seen Canada’s Major Drilling re-enter the Australian market with the $80 million buyout of privately-owned McKay drilling, while Dynamic paid $21.4 million to add Orlando Drilling and its 17 rigs.
Allen said more M & A activity is on the cards.
“I certainly think there’d be consolidation,” he said.
“If you’re a private guy unless you’re really big, and there’s not many really big ones left, I think I’d be more inclined to think about being taken out if that was the exit strategy they were looking for.”
“In lots of ways these transactions are actually occurring at higher multiples than the listed market is willing to pay at the moment.”
DDH1 has historically specialised in delivering long diamond holes from surface, boasting records for the longest exploration, water and electrical drop holes completed in Australia.
Allen said DDH1, which merged with Strike Drilling and Ranger Drilling before its IPO, was one company that could be on the lookout for acquisitions to broaden its offerings.
“DDH1 has made no attempt at hiding their ambition at going underground,” he said.
“I’m sure they’re looking at a number of underground drilling opportunities, as will others.”
“It’s still fairly fragmented as a marketplace.”