Originally I wanted to ask: "Is it safe to get back into mining services companies?" But, I thought it would be better to ask: "What should we know if the worst is behind us?"
Getting past the setbacks of 2013, have mining services companies' share prices fallen to oversold levels or can we expect further sell-downs?
Monadelphous Group Limited (ASX: MND) said in its November AGM presentation that it experienced a surge in construction activity, but then market conditions softened and mining capex moderated to normal levels. Coal and iron ore are the top two revenue sources with oil and gas in third.
Looking over the past 10 years of earnings per share growth, using a median growth rate will give us a better look at how the company usually performs without reliance on the "boom years" puffing up results.
That comes out to 15.2% median annual growth. In December the share price got clubbed down to $15. Although it has recovered to $16.79, the current dividend yield is still 8.16%.
That would be attractive if dividends weren't reduced, but if the company regularly pays out 80%-85% of its earnings as dividends and earnings fall from 170.5 cents per share in 2013, by let's say 20%, then dividends go down, too.
If EPS were to return to about 140 cps, then 112 is 80% of that and on a $16.79 share price, that is more like 6.7% yield – still good, and on a conservative view of the share price.
Putting all that together for a "back of the envelope" premium/discount calculation on value, 15.2 + 6.7 = 21.9, and dividing that by the 9.84 PE, the 2.2 ratio would indicate that we are not paying a premium on the future earnings growth potential of the company.
Foolish takeaway
Does this simple ratio mean that the company will not see further business and share price reduction? No. Does it tell us the exact intrinsic value of the stock? No again.
Just like the PE ratio doesn't tell 100% whether a high-flying stock is still a good buy based on future potential, we use these tools and standards to get a fair view of how a particular stock matches up with our investment strategy. Only after getting a basic financial understanding of a company's business would you be able to say if you want to look further into buying into it.
Investors should be running the ruler over other companies like WorleyParsons Limited (ASX: WOR), Cardno Limited (ASX: CDD) and Bradken Limited (ASX: BKN) to know when prices enter discounted territory.
Looking at the long-term view, the company will moderate back to median levels, so if most of the discounting has taken place, then there is less of a chance that the company will fall further unless new updates reveal a weaker business environment.
