Life as a mining contractor, no matter what the size or specialty, has become significantly more bearable in the past 12 months, thanks to a favourable shift in trading conditions sparked by the latest resources rally.
After several flat years in which it has been a dour struggle to win new work and turn a profit in the process, the pressure on the contracting sector has eased somewhat due to the situation created by high commodity prices, strong demand for raw materials from China and India, and economic recovery in the United States. This has translated into new project starts and major expansion activity, both in Australia and abroad, meaning more opportunities for everyone in the contracting game, and less cutthroat competition.
The best reflection of the abundance of work in the offing is provided by the forward order books of the three dominant groups – Leighton Holdings/Thiess, Downer EDI/Roche Mining and Henry Walker Eltin – which all sit at record levels. Leighton leads the way with $12.8 million, followed by Downer with $6.4 billion, and HWE, which almost doubled its work in hand to $3.5 billion in one fell swoop last month when it secured a 10-year term at Kaltim Prima Coal’s Bengalon project in Indonesia. At a step down in size, Macmahon Holdings has won about $800 million of new contracts in the past 10 months and is also carrying a record amount.
However, it will take another six months or so before this slab of new contracts starts to factor into financial results, at which point it should be possible to get a handle on who has capitalised the most out of the upturn.
At the moment, analysts say a number of companies are still dealing with the legacies of the lean period from which they have just emerged.
“Most of them are not going to have that special 2004s to be honest,” said Paterson Ord Minnett’s Rob Brierly. “It’s more or less 2005 when they’ll be starting to get that first flow on from that new work they’ve won over the past 12-18 months, because the lag is that long.
“They’re all still suffering a little bit from the hangovers of the past. It does take a while for the old projects that were probably won in highly competitive times to fall off the order book and get replaced with decent work.”
According to Brierly, one of the biggest challenges for companies seeking to make the most of the improved operating conditions has been restoring some balance sheet respectability. “They’ve just come out of a major low point, which has left some of their balance sheets looking less than ideal,” he said. “There’s been several companies that have taken advantage of the better trading conditions to improve their balance sheets, and therefore increase their financial flexibility so they can win more contracts.”
The list of contractors that have approached the market with equity raisings to strengthen their financial position in the past six months includes Macmahon, HWE and prominent drilling group Ausdrill. All these companies met with their share of adversity during the downturn, but have demonstrated resilience and are now at various stages on the comeback trail.
For a time there, Macmahon looked like succumbing to a string of hefty losses and ballooning debt, but has pulled itself back from the brink and is set to post a third consecutive full year profit. The company recently upgraded its 2003-04 earnings forecast from $8.5 million to $9-10 million, after the better than anticipated start-up of new longer-term contracts.
The outlook for 2004-05 was even more positive, according to managing director Nick Bowen. “On the back of a $740 million order book and strong tendering activities, the group expects significant growth next year,” he said. “The estimated profit after tax from 2004-05 is now expected to be $14 million on total sales of $525 million.”
HWE is running a little behind Macmahon on the recovery timetable, and is just starting its return to profitability after undergoing comprehensive restructuring to stabilise the business. It posted pre-tax earnings of $6.9 million for the first half of 2003-04, while a revised forecast last month estimated full year earnings of $12-14 million, factoring in a $2 million reduction caused by the impact of record rainfall on the company’s activities in Western Australia during March.
James was somewhat taken aback by the market’s negative response to this advice, suggesting the impact of the extraordinary rainfall event had been overstated. “I was surprised by some interpretations of that guidance given that the unfavourable impact of the inclement weather on our earnings in the second half of financial year 2004 has not been permanent,” he said. The outlook for the 2005 financial year remained positive, with a strong recovery in EBIT (earnings before interest and tax) forecast.
James said continued margin improvement was expected as the change in contract mix evolved. “Our focus over the past 18 months has been to improve returns across our business,” he said. “Old, unprofitable contracts have been exited and the new contracts we’re entering and intend to enter are more flexible and will generate improved returns.”
After winning the $1.7 billion Bengalon contract, the largest in its history, HWE’s forward revenue position only looks like getting stronger. The company currently has another $400 million of work, mainly Australian contract extensions, under final negotiation.
Increasing demand for exploration and drill and blast services has driven the “spectacular” turnaround in Ausdrill’s fortunes. In 2000, the company was left lamenting the severe downturn in mining activity in the wake of a $9.9 million loss. “We have never before experienced a mining market where demand for services and prices have fallen so far and have stayed down for so long,” it said at the time.
At last year’s annual general meeting in November, chairman Terry O’Connor informed shareholders that the company was in the best financial position in its history with a strong outlook in all operating markets.
“While the record profit for the financial year ending June 2003 included both positive and negative one off items, the key was the continuing strong operational performance,” he said in his address. “This performance, which was underwritten by our core operations in the WA Goldfields region coupled with the strength of the iron ore sector in the Pilbara region, provides the basis for our confidence for the immediate future.”
Ausdrill has consolidated on that record profit of $10.5 million by posting earnings of $3.9 million for the first half of the new financial year.
Although balance sheet strength puts companies in a better position to pick up quality work, it is not enough to guarantee protection from problem contracts, as Leighton has found. The contracting giant’s 2003-04 performance will suffer as a result of a $70 million provision to cover losses and long delays in the redevelopment of Sydney’s Hilton Hotel and Melbourne’s Spencer Street Station, and a $16 million write-down related to the balance of its investment in the fire-ravaged Southland Colliery.
