Features, Opinion

New spring in the mining-services step

Impressive turnaround for some stocks but much ground to make up. By Tony Featherstone.

After several tough years, parts of the listed mining-services sector are roaring back to life, creating opportunities for investors to capitalise on the next leg of the mining boom.

Australian Resources & Investment (AR&I) analysis of 23 mining-services stocks shows a median total return (including dividends) of 29 per cent over one year to July 2021. 

That’s better than the 23 per cent total return in the S&P Small Ordinaries index over that period. And a remarkable turnaround for a sharemarket sub-sector under pressure. 

Several mining-services stocks have starred: Cardno has a one-year total return of 196 per cent after steep falls in 2019. Mining-software group RPM Holdings is up 143 per cent. 

Although recent gains impress, mining-services stocks have much ground to make up. AR&I found the median three-year total return for mining-services stocks was just 2.5 per cent. Few parts of the market have been as out of favour as mining services in the past few years.

That is no surprise. Mining-services companies were hit with a tsunami of challenges: COVID-19 disrupted all industries and sparked shutdowns at some mines, particularly overseas. It also caused labour shortages, wage-inflation pressures and other supply-chain complications. 

Fund managers were concerned about the earnings viability in mining-services contracts, fearing providers had little recourse with large mining companies that halted projects because of COVID-19. In a volatile sharemarket, mining-services stocks were harder to buy.

The three-year total-return figures tell the story (see table on page 8). Most ASX-listed mining-services companies have a negative total return, or low single-digit annual return, in that period. 

A year ago, several mining-services stocks traded at multi-year lows. Strong gains over one year look good on paper, but won’t please
long-suffering shareholders.

However, every stock has its price. Cadence Capital founder Karl Siegling examined mining-services stocks after their share price tumbled last year. Siegling, one of the Australian sharemarket’s top contrarian investors, is known for buying deeply out of favour stocks – when other investors have given up on them or stopped looking.

“Things looked awful for mining-services companies,” Siegling tells AR&I. “But around June this year, it felt like conditions started to change. It was clear from my visits to mining-services companies that demand was improving. Share prices of key mining-services stocks were starting to trend higher again, which fits Cadence’s investing style.”

Siegling has been around long enough to know that contrarian investors never pick the exact bottom with turnaround ideas. 

“If the latest COVID outbreaks linger, we might see mining-services stocks give back their recent share-price gains,” he says. 

“But I’m confident we are close enough to the bottom – and that there is sufficient margin of investment safety – to buy.”

Siegling’s preferred mining-services picks are Emeco Holdings and MACA. He was impressed by MACA’s recent acquisition of Downer EDI’s Mining West business. Perenti Global also looks cheap, says Siegling, but the company is resolving internal issues. 

Montgomery Lucent Investment Management, another leading value investor, is also bullish on mining-services stocks. 

In May, Dominic Rose, portfolio manager at the Montgomery Small Companies Fund, wrote favourably about four mining-services stocks: Seven Group Holdings, Imdex, NRW Holdings and Mineral Resources. 

Rose wrote in May 2021: “We have recently taken advantage of depressed valuations and selectively added to our small-cap mining-services exposure. While this is a cyclical sector, the risk-reward profile appears better than prevailing share prices would otherwise suggest.”

Montgomery’s bet on mining services is paying off. Mineral Resources has a total return of 143 per cent over one year. Imdex is up 64 per cent over that period; Seven Group Holdings has returned 32 per cent; and NRW Holdings has a slight negative return.

Care is needed with one-year results. Several mining-services stocks are bouncing off multi-year lows, which amplifies percentage gains in the share price. But there’s little doubt that mining-services stocks, collectively as a sub-sector on the ASX, are starting to turn.

Leveraged to mining growth 

Fund managers view mining-services companies as a “second-derivative” beneficiary of the commodity price booms. 

Rising minerals prices encourage more Australian mining and energy companies to raise capital and explore, more increase production. That’s good for mining-services companies that supply goods and services for mining activity.

Thanks to COVID-19, opportunities in this exploration cycle for mining-services companies could be magnified in the next few years. 

Australian non-ferrous metals exploration budgets fell 12.5 per cent year-on-year, according to Standard & Poor’s World Exploration Trends 2021 report. 

However, S&P forecasts global exploration spending to recover strongly amid the COVID-19 vaccine rollout and favourable metal prices. If S&P is correct, demand for mining services in Australia and overseas will rise.

A solid recovery in global economic growth should underpin higher commodity prices, resource activity, and thus higher earning for mining-services companies. 

In the June 2021 Resources and Energy Quarterly, the federal government states: “The outlook for Australia’s mineral exports continues to improve, as the world economy rebounds from the impact of the COVID pandemic. As the world economy recovers, record iron-ore prices have driven a surge in export earnings. Our metallurgical coal-mining firms are also benefiting from the surge in world steel production.” 

The International Monetary Fund forecasts global economic growth of 6 per cent in 2021, after a contraction of 3 per cent in 2020 due to the pandemic. The IMF forecasts world growth to moderate towards more typical levels in 2022 and 2023.

Rising investment

The key for mining-services companies is the level of mining investment. About $8.1 billion was invested in the March 2021 quarter, up 1.3 per cent on the same quarter a year ago, the Australian Bureau of Statistics Private New Capital Expenditure and Expected Expenditure Survey found.

The ABS found mining expenditure rose for buildings and structures, and for machinery and equipment, in the March quarter. Spending on mining plant and equipment remains above its average level in recent years, found the ABS. 

The government’s Resources and Energy Quarterly states: “Forward expectations suggest that (mining) investment in 2020-21 will be slightly higher than in 2019-20. Strong prices for gold, iron ore and other minerals are leading to new investment plans, including the re-opening of mines. However, investment in new greenfield projects remains well below the levels of the previous decade, when seven LNG plants were built.”

On exploration, data suggests mining capital expenditure is recovering at a marginal pace following falls in early 2020, the government states. Exploration spending edged up in the March quarter, with exploration spending for all commodities reaching $956 million.

Clearly, mining-services bulls hoping for a sharp upturn in mining-investment activity, and thus mining-services demand for exploration and production services, will be disappointed. 

But after lagging the sharemarket over several years, mining-services company valuations had much bad news factored into their valuations – meaning they are poised to surprise on the upside. 

Mining-services stocks can be a great investment when resource companies boost exploration spending and get more projects into production. Conversely, they can be terrible investments when mining capital-expenditure cycles turn, leaving mining-services companies with expensive equipment that depreciates as it sits idle. 

The trick is buying mining-services stocks at the right time in the commodities cycle – knowing the risks and being prepared to take profits – rather than adopting a “buy-and-hold” strategy. 

For all the challenges, Australia has a great mining-services sector and a world-class resource industry. When COVID-19 finally clears, few parts of the sharemarket are better placed to benefit from continued strong growth in Australian resources than mining services. 

Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at July 31, 2021.

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