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Is now the right time to buy NRW Holdings?

On Tuesday morning, NRW Holdings (ASX: NWH) became the latest company in the mining services industry to downgrade its earnings guidance. The company announced that it expects to make $73-$76 million net profit after tax (NPAT) for the full year, on revenue of about $1.3 billion. This compares to a previous guidance of $84-$90 million, based on revenue of $1.4-$1.5 billion. Shares closed down 6.5% for the day, at $1.01, corresponding to a market capitalisation of just under $282 million. Net debt was about $30 million at the end of the last half.

In my view, NRW Holdings is trading at attractive prices for long-term investors searching for a decent dividend yield. Based on the updated guidance, NPAT for the half year to 30 June 2013 should be at least $24.4 million. Historically, the company has a paid out about 50% of earnings as a fully franked dividend, although the payout ratio last half was slightly lower, at 46%. Based on this figure, and using the low end of the updated forecast, investors can reasonably expect a final dividend of at least 4c per share. At a share price of $1, that would represent an annualized, grossed-up yield of 11.4%.

On the other hand, investors need to consider the risk that profits may drop further in FY 2014. The mining services sector has seen a slew of profit downgrades in recent weeks. For example, Coffey International (ASX: COF) released a profit downgrade in May, precipitating a share price drop of over 50%. In particular, Coffey’s Geosciences business is performing poorly as a result of projects being delayed or cancelled due to falling commodity prices.

Similarly, driller Boart Longyear (ASX: BLY) blamed the delay and cancellation of exploration contracts last month, when it announced that earnings would be at the lower end of the range of current analyst forecasts. It is no surprise that NRW Holdings has also been impacted by the downturn in capital spending.

In contrast to Coffey International and Boart Longyear, civil contracting brings in about half of NRW Holdings’ revenue. The civil contracting business (building roads, infrastructure and earthmoving) relies more on operating mines than on new projects, which are generally the first to be delayed or cancelled when commodity prices fall. In the downturn of 2008 and 2009, earnings per share dropped to 13.6 cents. The company continued to pay a dividend, although it did drop as low as 2c for the full year in 2009.

These days, a very significant proportion of the company’s revenue is related to the export of iron ore, meaning profits are leveraged to commodity prices, which are notoriously difficult to predict. Further, the stock has been heavily shorted in the last few weeks, and the share price has been volatile. A dividend cut is inevitable, and the company will struggle to grow earnings until mining activity picks up.

Foolish takeaway

Contrarian investors should put NRW Holdings on their watch list. While profits seem likely to fall in the short term, investors stand a good chance of being paid a decent dividend while they wait for an improvement. At that point, the market may once again offer a premium price for a company in an inherently cyclical industry.

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Motley Fool contributor Claude Walker does not own shares in any of the companies mentioned in this article

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