catch the rabbit !

Mining services taxi on their runway.

CRITERION: Tim Boreham | August 19, 2009
Article from: The Australian.

ONLY a couple of months ago the sprawling mining services sector was doing its best imitation of a rabbit caught in the headlights. Now there's a sprightly spring in those bunny hops as contracts start to flow again. Share values have also recovered -- often from abysmal lows -- and the question is whether investors have missed the recovery.

The answer is probably not, but a valuation dichotomy has emerged between the industry leaders -- the Leighton Holdings, Oricas and Downer EDIs -- and the less understood minnows and mid-sized players.

High gearing also remains an issue.

The renewed optimism was summed up by Leighton chief Wal King, who this month reported a near-record order book and a shortage of mining equipment. "The question that no one can answer is: will this demand be sustained?" he told a miners' chow-down.

Bell Potter analyst John O'Shea cautions that the sector has to be viewed on a case-by-case basis, and it's not exactly a matter of demand reverting to boom-time conditions: "The issue has been that on the upside, people were too bullish that companies would continue to win contracts and grow earnings. On the downside, people thought the world was going to end -- but the world did not end."

O'Shea cites Bradken (BKN), which builds railways and supplies other goods to miners. Bradken reported flat earnings of $69.9 million for the year to June 2009 and forecast a similar flat result in the current year.

Not wildly encouraging, but brokers had pencilled in a consensus $57.3m result for 2009-10, 18per cent lower, and the stock rallied accordingly.

Another case in point is Industrea (IDL), which made the mistake of buying Mt Isa's Huddy's Mining Services for $250m at the height of the market. Huddy's in January lost a contract to service Xstrata's scrapped Handlebar Hill mine.

Industrea CEO Robin Leveson promised to fill the revenue gap, but investors were sceptical. As it happened, management has done just that with new coal contracts, notably a $30m-a-year deal with Cockatoo Coal's Baralaba coalmine.

Similarly, MacMahon Holdings (MAH) missed out on a whopping $500m contract to develop the site for the Gorgon LNG project, but last month was awarded a $110m extension for underground development of the Olympic Dam mine. "We had not assumed any additional contract wins in the mining division this year and have upgraded our forecast for the business segment accordingly," broker Patersons says.

Leveson says: "We're seeing a strong momentum building, but it's a very mixed sector. You have the absolute minnows and then you have the Leighton and the United Groups which are trading on much more attractive (higher) price-earnings ratios."

A feature of the sector is that (by and large) it hasn't participated in the broader capital raising spree. With many of the stocks still troubled by high debt, it's reasonable to expect more equity raisings as valuations recover.

On this note, global drilling services provider Boart Longyear (BLY) is a dramatic example of underperformance, with its $680m debt load (a gearing ratio of more than 400 per cent) playing a starring role.

"Given the likely fall in the company's earnings in 2008-09 and existing debt covenants, we expect the company to review its capital structure before year end," says Deutsche analyst Philip Pepe.

Boart Longyear's revenues were expected to decline 40 per cent in calendar 2009, with Deutsche expecting a $2m loss. But a strong kick-up is expected in 2010 as the "relationship between exploration budgets and commodity prices returns to normal".

Here's hoping, because fillet mignon tastes much nicer than rabbit stew.