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2 undervalued mining services with high yields

There’s no business like mining services when it comes to cyclical behaviour – up by the stairs, down by the lift. Many companies in this sector have seen price declines of 70-80% in the last two years, especially down the small-cap end.

Is it a good time to buy? The answer depends on the level of individual company exposure to ongoing production, financial health and the extent of any market undervaluation.

Ausdrill’s (ASX ASL) major contract exposure is to iron ore, gold and copper. Customers include BHP, Rio and Newmont. Importantly, 68% of Ausdrill’s revenue is estimated to be from non-discretionary production expenditure and low-cost producers. Therefore the revenue base is reasonably protected, although net margins will certainly be affected by current industry malaise.

In addition, Ausdrill has an expanding and profitable contract mining operation in Africa, a supply and logistics division and a small specialist manufacturing facility (drill bits, etc.). These operations contribute a further 21% of revenues. Only 11% of revenues are exposed to exploration.

Ausdrill is ok financially with a gearing ratio of 38%, interest cover of 9, and a clean balance sheet. Net tangible assets are $2.28 per share.

Although Ausdrill’s share price has increased 35% in the last few weeks, the company remains significantly undervalued. At $1.12 the 2013 price earnings ratio is estimated to be 3.8. A decrease in 2014 earnings of 25% would see forward price earnings of 5. With a minimum dividend yield of 10% fully franked, Ausdrill is definitely one to consider.

Mastermyne’s (ASX: MYE) resource exposure is to underground black coal, and it has geographic exposure to Queensland (Bowen Basin) and New South Wales (Illawarra). Mastermyne provides a range of specialist underground services including engineering, maintenance, a training facility and equipment hire. With the ability to be the only contractor on site, Mastermyne is well regarded in the industry and has BHP and Rio Tinto as major customers.

Although prices for categories such as metallurgical coal have fallen dramatically over the past 12 months the longer term outlook for coal is strong due to increasing demand from India and the global uptrend in industrial production.

Mastermyne is healthy financially and has the capacity to take up opportunities as they arise. Depreciation (a non cash item) is high as the expense of equipment is written off. However the ownership of specialised mining equipment is a distinct advantage when tendering for contracts.

At 73c, Mastermyne has an estimated 2013 price earnings ratio of 4 (EPS 18c) and a dividend yield of 8% fully franked. The 2014 first half is expected to be weak, with a strong pickup occurring in the second half. Estimated 2014 EPS is 15c, giving a price earnings ratio of 4.8. This specialist contractor is undervalued.

Foolish takeaway

Of course there is risk with investing in shares driven by excessive market sentiment (whether up or down). In the mining services sector bears have had an enormous picnic and a value seeking Fool may find the occasional honey pot amongst the debris. Ausdrill and Mastermyne have the characteristics of longer term thrivers.

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Motley Fool contributor Peter Andersen owns shares in Ausdrill and Mastermyne.

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