Analysts and commentators have suggested the mining services sector needs to brace for more mine closures and job losses in the year ahead.
Rail and port operators will also face reduced volumes as take or pay contracts are renegotiated.
A new report by Newport Consulting has found that just 16% of mining leaders are cautiously optimistic about their growth prospects in the next 12 months. The consultants interviewed more than 50 mining leaders to get their views.
Here are some more key findings from the report:
- 78% will reduce their capital expenditure this year, more than double that of last year. 16% are increasing their spend – compared to 81% in 2013.
- 80% of leaders plan to cut headcount, up from 50% last year
- 84% of leaders are NOT optimistic about their future growth prospects. For the second year in a row, none are very optimistic
- Half of all leaders are focused on cost control and management as flat conditions continue while others labelled efficiency as their top priority.
- Productivity is one of their key challenges, with one mining services leader saying, "Exploration has slowed dramatically. This will result in major issues as new developments will be late coming online or never developed. We need to substantially increase our levels of productivity per employee."
- 28% of miners remain in the higher production cost quartiles, suggesting more cost cutting is coming.
- The cutbacks confirm the Reserve Bank of Australia's fears that some mining services companies could default on their debt because of lost contracts and fewer orders.
The top 3 strategies – which you can pretty much glean from the list above is 1) Productivity, 2) Cost control and 3) Mine closures.
We've mentioned this before, but winning multiple contracts is not the same as growing profits. Contracts can always be cancelled or disappear totally if mines close or miners go bust, and there's not much the contractors can do about it. In many cases, margins are likely to be much thinner – for contractors that already have thin margins.
According to data from CapitalIQ, median profit margins across the construction and engineering sector have dropped from 6.1% three years ago to 1.6% in the last 12 months.
Revenues have dropped 18.5% across the sector over the same period, while total reported net income has gone from $858.6 million in 2012 to just $50 million last financial year. That's across 38 construction and engineering companies.
Sure, some may do well. With miners like Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP) increasing production of iron ore, those companies contracting on the production operations should do ok. At worst, they'll still be generating revenues and may even be making a small profit.
Some projects are still going ahead like Sirius Resources N.L (ASX: SIR) Nova nickel project, so there will be work for some lucky contractors. The problem they face is what do they do once the contract ends? Mineral exploration has virtually dried up as has capital expenditure on exploration both for brownfield (existing) and greenfield (new) sites.
That suggests there's going to be a big lag between when exploration begins in earnest again and when mining projects reach the engineering and construction stage. It can take up to 10 years or longer for some project to go from discovery to initial production.
Contractors like Monadelphous Group Limited (ASX: MND), RCR Tomlinson Limited (ASX: RCR) and Decmil Group Limited (ASX: DCG) look cheap, trading on single-digit P/E ratios and huge dividend yields. Other might appear cheap on price to book value ratios or a net tangible assets basis.
But the danger remains that they could become even cheaper still. Just today, MMA Offshore Ltd (ASX: MRM) wrote $100 million off the value of its vessel fleet, previously valued at $884 million.
Australia still has several large projects, including LNG projects, that are nearing completion – and very few new ones on the horizon. Once in the operational phase, there's not going to be much contracting work left.
Infrastructure operators yet to face the music
Rail operators like Aurizon Holdings Ltd (ASX: AZJ), ports and infrastructure owner Ascianco Ltd (ASX: AIO) and Qube Holdings Ltd (ASX: QUB) could also be companies to watch as contracts are renegotiated and commodity volumes fall. Qube has already experienced this – renegotiating its contract with Atlas Iron Limited (ASX: AGO) and receiving shares in the company as part compensation for lower rates and kicking in capital.
Foolish takeaway
Several fund managers and investors have bitten the bullet and dived into the mining services sector, perhaps a bit too early and have already been stung. We probably haven't seen the bottom yet, and Foolish investors may want to continue to steer clear of the mining services sector and keep an eye on the infrastructure companies mentioned above.
