In a mining services report, Patersons warned that, while capitulation was still to come, the two ASX-listed players were suffering from cost restraint from the major resources companies and were at the wrong end of the survival spectrum.
Describing Macmahon as hostage to the bank syndicate, Patersons said the contractor was struggling to deal with the loss of its largest mining contract at Fortescue Metals Group’s Christmas Creek mine, which represented around 35% of its revenue.
The loss cost Macmahon hundreds of millions of dollars and followed earlier, costly issues such as the loss of the CSA Cobar contract with Glencore and a contract dispute in Mongolia.
“In the absence of a white knight or a compassionate financier, Macmahon are under enormous financial pressure,” Patersons said. It issued the firm a negative rating and advised investors to sell their stock, which it valued at $0.042 per share, although admitting that a resolution of the Mongolia dispute could potentially inject up to $0.08 per share of cash into the company.
Patersons also gave NRW Holdings a negative rating, describing the firm as “too risky” as an investment as it tries to work its way through a major drop in workload and a problematic civil construction contract at the Roy Hill iron ore project, which extended renegotiations have left Patersons pessimistic.
“We remain pessimistic as to its chances of financial favour (like trying to get blood out of a stone),” it said.
“While it seems that the company is only lightly financially geared (net debt to equity ratio of 11.7%), breaches of financial covenants tend to test the resolve of financial institutions as does the savage drop-off in revenue expected from H2FY15 ($570 million in H1 vs c.$200 million in H2).
“NRW Holdings wrote down $134.9 million (pre-tax) worth of assets in H1FY15 mainly due to its carrying value of high hour, low utilisation and non-core fleet.
“The company also impaired goodwill of its AES business. These write-downs are indicative of the market.
“As at 31 December 2014, NRW Holdings had a healthy cash balance of $138.9 million but had a total debt burden of $166.8 million.
“We value NRW Holdings at $0.19 per share, which is close to its current trading price and rate the stock as a SELL.”
Other mining services providers analysed in the report include Ausdrill, LogiCamms and MACA – all of whom were issued neutral ratings – and Tempo Australia and Valmec, which scored a speculative buy rating.
Diversified service providers such as Monadelphous, MMA Offshore, RCR Tomlinson and Fleetwood were not reviewed in the report, but Patersons made some optimistic remarks on their ability to offset financial strains in the mining sector with other activities.
“We believe that these companies have significantly different points of leverage,” the stockbroker said.
“We have positive ratings on MMA Offshore (marine services) and RCR Tomlinson (infrastructure) and neutral ratings on Monadelphous and Fleetwood.”
With an expectation that commodity prices will stay weak until next year, Patersons advised investors to keep an active eye on their stock, as some companies may be gone before then.
“We do not feel that the bottom of the cycle has been reached but we do suggest that the time may be ripe for the discerning investor to look at which sector participants will survive and ultimately flourish when the cycle picks up,” it said.
“Our investment thesis is that the sector, as a whole, is yet to bottom out but there are companies that have the management prowess (Ausdrill, Tempo Australia and Valmec), financial stability and capacity (LogiCamms and MACA) and product offering (Ausdrill and Tempo Australia) that differentiate them from the others.”
Patersons concluded the exit of some struggling players in the mining services sector may help rebalance supply and demand.
“It is our view that the sector is finally now readjusting to the new industry backdrop [since commodity prices began falling in 2013], and it will be necessary for some services companies to leave the industry so that a rebalance of supply and demand can occur.
“Companies likely to leave the industry are those that have little to no intellectual property and/or have high levels of debt that may lead to voluntary administration.”
