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Macquarie comments...

Boart Longyear
Earnings revised

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Volatility Index: very high
Recommendation: Neutral


Event

Boart Longyear (BLY) provided a market update on current trading conditions and its 2009 outlook. Weak demand conditions are continuing into second quarter across Services and Products. Earnings before interest, tax, depreciation and amortisation reductions will likely be most severe in Drilling Products due to very depressed levels of capital equipment sales. BLY has partially offset the impact of lower revenues with cost-reduction actions undertaken late last year. Global headcount now totals less than 7,000 (a 30% reduction on pcp). However, the full impact of cost-cutting initiatives will not be felt until second quarter.

Impact

financial year 2009 revenue now expected to be 35-45% lower than in financial year 2008 (vs our prior estimate of down 36%). The main negative surprise was margins, with earnings before interest, tax, depreciation and amortisation margin before restructuring now expected to be 11-13% (we previously assumed 16%). Our revised revenue and earnings before interest, tax, depreciation and amortisation margin forecasts are at the lower end of both ranges (down 46% and 11%).

Formal debt refinancing discussions have yet to start; outcome likely to take 6-9 months. Based on discussions to date, BLY's current expectations are that revised financing arrangements will be in place by the year-end (before the end-2009 covenant compliance tests and in advance of April 2010 US$585m debt maturity). Net debt is expected to be reduced by about US$100m at the year-end, to below US$700m. On the positive side, the business is free cash flow-generative in a downturn and even on trough cycle earnings BLY appears able to service its debt (financial year 2009E earnings before interest, tax, depreciation and amortisation US$110m to cover projected interest payments of US$38m). At some point in the future, earnings will rebound along with the cycle. There are 16 banks in BLY's syndicate, which increases re-financing risk although there are reasonable quality banks involved, namely, CBA, NAB, ANZ, RBS, Paribas, Bank of America, HSBC. Other options of asset sales and equity raising are not ideal given the current pricing.

Based on its revised guidance, BLY is likely to breach the financial year 2009 covenant and earlier 12-month to 30 June 2009 measures not without risk. We estimate financial year 2009 net debt/earnings before interest, tax, depreciation and amortisation of 6x, which would be in breach of the minimum 3.75x level. We note this is a 12-month trailing test; ie, first half 2010 would be the relevant period to test financial year 2009 earnings before interest, tax, depreciation and amortisation, by which time BLY expects to have refinanced its April 2010 debt. However, October 2009 is the next covenant assessment period (12-month results to 30 June 2009). Based on our first half earnings before interest, tax, depreciation and amortisation forecast of US$38m, BLY's trailing 30 June 2009 net debt/earnings before interest, tax, depreciation and amortisation is 3.7x, which is close to the maximum level. So this represents a risk factor over the next few months.

Earnings revision

We now expect losses at the net profit after tax line in financial year 2009 (-US$14m vs our prior US$42m estimate). We have reduced our financial year 2010 earnings per share forecast by 19%.

Price catalyst

12-month price target: $0.16.

Catalyst: Extent of any second half demand recovery, debt re-financing progress over the next 6 months.

Action and recommendation

We retain our Neutral rating with a A$0.16 target price. The stock is captive to ongoing balance sheet/debt concerns and a high level of earnings risk. Until these issues are resolved (which still appears some way off), the stock is likely to remain cheap.