The Australian Financial Review has published an article titled, 'Fire sale for mining services leftovers'. While the focus of the article was on the excess supply of transportable accommodation once destined for remote mining sites, the implications for the asset quality and stated book value of all mining service firms' balance sheets should be questioned.
Given the severe downturn in future contracted work faced by many firms, it should be expected that sales of idle earth moving equipment will increase too. This increase will undoubtedly lower prices and could lead to companies being forced to write-down the value of their assets.
There are important lessons in this not just for investors but also for company managers. A business should not be managed as though a boom will go on forever and likewise, a business completely reliant on continually winning new project work should tread carefully.
A common 'screen' or valuation tool investors use is to value a business based on its net tangible asset (NTA) backing, which is a more conservative measure than simply net assets. Investors studying the share tables will no doubt be noticing the increasing number of mining service firms currently trading well below their NTA. These include well-known companies such as Ausdrill (ASX: ASL), Boart Longyear (ASX: BLY) and Emeco Holdings (ASX: EHL). While this can immediately spark interest for investors and indeed warrant further investigation, there appears to be good reason why the market has market the price of these firms down.
Earth moving equipment, which can make up a substantial portion of a mining service companies assets, sits within the 'property, plant and equipment' segment on the balance sheet. The problem is, what the statement of financial position (the balance sheet) states the property, plant and equipment is worth may not be anywhere near what a company could actually sell its equipment for today or in the future.
Foolish takeaway
Buying companies for less than NTA makes inherent sense but it is not without risks. Investors need to be diligent at considering the risks of the NTA value decreasing and at estimating an accurate, 'real time' value of the assets as opposed to the stated historical book value.
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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.
