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Outlook weakens for mining services

Signs that the resource sector is slowing have continued, with mining services and construction contractor Leighton Holdings (ASX: LEI) informing the market that it will cease mining operations at the BHP Billiton Mitsubishi Alliance (BMA) Peak Downs coal mine in July. Leighton’s contract was due to run until 2015 and the early termination will reduce future revenues by $260 million, although some compensation for early termination is expected.

There was no word from BHP Billiton (ASX: BHP) on what is happening at BMA but with the big miners currently employing more external contractors than staff on their books, contractors will be the first to go as miners adjust their cost base for slower demand from China and lower commodity prices. This leads me to speculate that BHP may be replacing Leighton contract workers with BHP employees and also potentially slowing down production rates at BMA. We should know more next week when BHP reports its March quarter results.

Pain likely to get worse

Smaller mining service firms such as RCR Tomlinson (ASX: RCR) are likely to bear the brunt of resource sector spending cuts, while top performer Monadelphous (ASX: MND) may not fare as badly given its stellar track record. It’s not just the firms that dig dirt that will come under increasing strain, Fleetwood (ASX: FWD) a provider of temporary housing to remote mine locations will also find its goods in lower demand.

Foolish takeaway

Here at Motley Fool we think taking a long-term view is important. A long-term view of mining service firms’ profit margins helps investors understand that the earnings of contractors during boom times are not sustainable in tough times. Fools looking at investments in mining services industry should consider the profit margins attainable as more firms compete for a shrinking pie of work.

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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 contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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