Mining investment accounted for two-thirds of economic growth in Australia in 2011 and 2012, the virtual peak of the resources boom.

Since then, mining investment has been falling and is likely to continue falling – by as much as 70% according to NAB Group Economics.

Mining Investment Jun 2016

Source: NAB Group Economics

 

As China’s appetite for resources slows, so too have commodities prices come off the boil, resources projects have been shelved, postponed and even cancelled, and mining investment has crashed. But despite the huge falls so far, NAB says its models suggest that mining investment is likely to fall by around 70% from its current level over the next three years (as per the chart above).

That has drastic consequences for employment and work in the sector. According to NAB, the mining sector lost 57,000 jobs between May 2012 and Feb 2015. The number of construction jobs has already begun to unwind and further losses over coming years are expected. NAB expects another net 50,000 mining jobs to go over the next two and a half years with 65,000 of those coming from construction – offset by the creation of 15,000 new operation-related jobs.

Several LNG projects are also nearing completion or are in the first phases of production, which has helped to prop up employment in the sector. However, as the construction phase of those projects winds down, there are further downside risks to employment and contract work in the sector.

NAB also points out that many mineral and petroleum producers have responded to the commodity downturn by resorting to cost-cutting programs, including a reduction in headcounts, metres drilled and exploration programs, particularly at greenfield sites.

This means the risks to the mining services – or construction and engineering – sector are probably higher now than at any time previously.

Further cost cutting and less investment mean less contracting work to go around, and those contracts will probably feature the skinniest of margins. One slip-up and contractors could end up buried.

While a number of fund managers have indicated they are jumping back into the sector, they could get their fingers burnt if the scenarios above play out.

As we pointed out yesterday, the mining services sector has been crushed over the past few years, but that may be nothing to what we are about to see. I should also note that the article yesterday didn’t include a number of mining services companies that have already fallen into administration, including Forge Group and WDS Limited.

If investors are thinking about dipping their toes into the sector, they need to be aware of the outlook for the entire sector.

Even arguably the best company in the sector, Monadelphous Group Ltd (ASX: MND) hasn’t been immune to the changes underway as the following table shows.

2012 2013 2014 2015 1H 2016
Revenues 1,897.5 2,614.1 2,329.6 1,865.0 737.0
Net profit 126.0 156.3 138.6 105.8 37.6
Margin 6.6% 6.0% 5.9% 5.7% 5.1%
EPS ($) 1.42 1.73 1.50 1.14 0.40
revenue growth 37.8% -10.9% -19.9% -29.9%
profit growth 24.0% -11.3% -23.7% -37.9%
margin growth -10.0% -0.5% -4.6% -10.1%

Source: Company reports

Revenues have been falling and margins are being compressed.

Foolish takeaway

It seems fairly clear that the construction and engineering sector still faces huge headwinds, and I wouldn’t be jumping into the sector just yet – if at all. The other problem is that companies struggling in the mining services sector will cast their eye into other construction sectors, and likely put pressure on the companies there too.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.