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Time to buy Monadelphous?

They say in a mining boom, it is those that sell the picks and shovels that make the most money. While there is much truth in that, it is also true that these are also among the first to suffer when the boom winds down.

In Australia’s most recent mining boom, the ‘picks and shovels’ handle (if you’ll excuse the pun) was perhaps best worn by the so-called mining services businesses. Take for example engineering company Monadelphous (ASX: MND), which over the past decade has delivered its shareholders an annual compound total return of over 30%, well in excess of BHP Billiton’s (ASX: BHP) 12% run rate.

As the saying goes, however, that was then, this is now. The once market-darling this week touched its lowest level in four years, with shares less than half what they were last year.

A solid history

Bargain hunters could well be tempted to run the ruler over Monadelphous; after all, the decline in share price seems disproportionate to the relatively benign drop in last year’s profits. Furthermore, this is no one-hit-wonder with Monadelphous regarded by many as the best in the business.

Management have been extremely selective in tendering for contracts, and have sensibly diversified operations across a range of commodities, including the still expanding oil and gas sector. Further, the business generates a meaningful proportion of its revenues through reasonably dependable maintenance work, which in fact should increase as more mines move into the operational phase.

This is a business with not much in the way of capital requirement and an ability and willingness to distribute most of the earnings back to shareholders through dividends. It is also a flexible operation; it enjoys a good deal of operational leverage and a fair degree of cost control.

An uncertain future

With the heady days of the mining construction boom clearly on the wane, prospective buyers must bear in mind that the future will likely be quite different from the past.

The business has historically enjoyed wonderful pricing power as its clients scrambled to ramp up operations, and competitive pressures were muted by the sheer abundance of available work. Today, though, there is much less work to be had, and that which is available is being aggressively fought over by a sector hungry for new contracts. Add to this a much more cost sensitive customer base, and you have a very tough set of conditions.

Management may be amongst the best in the business, but there is little they can do to offset the brutal combination of less work and shrinking margins. Though maintenance and industrial service work will provide a much needed supply of revenue, the majority of earnings are still skewed towards the more profitable front end engineering and construction contracts.

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Andrew Page is a Motley Fool analyst. You can follow The Motley Fool on Twitter @TheMotleyFoolAu. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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