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Mining services not out of the woods

Exploration expenditure in Australia is expected to peak in 2013, according to the Reserve Bank – but judging by data from the Australian Bureau of Statistics (ABS), it may have already peaked in the December 2011 quarter.

ABS Mineral Exploration

Source: ABS Mineral and Petroleum Exploration September 2012

In a further sign of falling spending, Rio Tinto Limited (ASX: RIO) has just announced that it is cutting its spend on exploration by $750 million in 2013, compared to the previous year. The Centre for Exploration Targeting believes that Australian spending on exploration may be entering a period of contraction. We could see the downward trend continue, without any real recovery, such as the one we saw in 2009.

That has major consequences for several mining services companies. We’ve already seen drilling products and services firm, Boart Longyear (ASX: BLY), issue two profit warnings, amid downgrades to its forecasts for the 2013 and 2014 financial years. At the forefront of falling exploration expenditure, its perhaps no surprise that Boart was one of the first to be hit.

Testing and inspection company, ALS Limited (ASX: ALQ), which relies to a large extent on exploration, recently reported that geochemical flows in to the company’s laboratories had been in decline for a number of months. While the company expects a turnaround later this year, it clarified that comment with “although this remains difficult to predict at this stage”. It seems the company has more hope than faith in the turnaround, and could be in for a nasty surprise.

Construction and project management, procurement and engineering companies will also likely be hit next as exploration expenditure falls reducing new finds and extensions to existing mines. In the short-term, mining blasting, haulage and crushing services will likely still be in high demand as miners ramp up production to fill in for lower commodity prices. Those services companies that provide pure production services, like MacMahon Holdings (ASX: MAH) should be fine if that is the case.

That is….until commodity prices fall.

Current iron ore prices are unlikely to be sustained, and most analysts are forecasting lower prices in the future.

Over the longer term, many mining services companies will struggle as miners then start to cut back on production, to cut supply, and wait for an increase in commodity prices. After all, this is a cyclical industry. Miners try to increase supply as demand increases, but at some stage, supply outweighs demand, which forces commodity prices to fall, and then supply tends to decrease.

Foolish takeaway

Mining services is a risky sector to invest in given the current trends.

Companies not solely restricted to the resources sector would likely be the better picks. Those with exposure to government construction and infrastructure projects as well as those with exposure to the oil and gas sectors, will likely do ok. With $160 billion of LNG plants alone under construction, and potentially more to come, such as Woodside Petroleum’s (ASX: WPL) Browse and Sunrise projects, companies servicing the oil and gas sectors should be able to secure contracts, grow earnings and see their share prices respond accordingly.

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More reading

The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool writer/analyst Mike King owns shares in Woodside Petroleum.

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