Is there value in mining services?

Several resources contractors are trading at mouth-watering valuations

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Analysing Australia's mining services companies suggests there could be a fortune in hidden value waiting for those brave enough to take the gamble.

Media reports suggest that international investors are definitely taking a closer look.

Corporate activity rising

Bradken Limited (ASX: BKN) which mainly supplies mining equipment, has already received one takeover bid in April for $2.50 per share from Pacific Equity Partners and Koch Industries, while Kohlberg Kravis Roberts (KKR) is rumoured to again be circling the company.

Meanwhile, Cardno Limited (ASX: CDD) is another that appears on the 'takeover' list, after Malvern Capital Investments purchased 10% of the company in one swoop in late May. Malvern now holds 18.7% of the shares in Cardno. The Australian Financial Review reported that Malvern is backed by private equity firm Crescent Capital.

And you can understand their interest when you look at how beaten up the contracting and engineering firms, and mining services sector are. It would be hard to find a more unloved sector of the market.

But smart investors like to fish in the waters the market is avoiding. Across the construction and engineering sector, the average P/E is just 10.9, while the average price to book ratio sits at 1.0, although many are trading at up to 80% discounts to their book value. Those include NRW Holdings Limited (ASX: NWH), Macmahon Holdings Limited (ASX: MAH), Ausenco Limited (ASX: AAX), and WDS Limited (ASX: WDS), with the latter trading at around a tenth of its reported book value.


Some, like MacMahon, even have tonnes of cash on their balance sheet. Macmahon last reported a cash balance of $124 million – the company's market cap is just $61 million. Admittedly, the company does have $161 million in debt too. But this is a company that generated $27 million in operating cash flow in the six months to December 2014, giving us a price of 2.3 times its cash flow.

NRW Holdings also has a substantial cash holding of $139 million, although it too has $167 million in debt due within the next 12 months. Like MacMahon, NRW delivered $30 million in operating cash flow for the last reported half. The company's market cap stands at just $53 million.

Saunders International Ltd (ASX:SND) sports a P/E of 8 and a dividend yield of 9.2%, fully franked. The company specialises in building large steel storage tanks for products like petroleum, LNG, gas and water. The company has a market cap of $51.5 million, $21 million in cash and no debt, and produced $2.7 million in profit in the first half of 2015.

And then you have Brierty Limited (ASX: BYL), with a market cap of $43.8 million, a P/E of 4.3 and$25 million in net debt — primarily from hire purchase agreements for equipment for a $300 million contract for Rio Tinto Limited (ASX: RIO).

For value investors, those numbers are mouth-wateringly tempting. But there are some concerns as you might expect.

You don't get a cheap price if there's nothing smelly.

Termination of MacMahon's Christmas Creek contract with Fortescue Metals Group Limited (ASX: FMG) triggered a debt review, the outcome of which is still unclear.

NRW expects the current year to be 'difficult', saying the industry faces strong headwinds, with capital projects deferred or cancelled, client-driven cost reduction programmes and a number of large projects not due to commence until 2016.

Brierty has also said that conditions 'remain highly competitive', but also provided a glimmer of hope for mining services companies — 'there was still work to be won at quality projects'.

Foolish takeaway

While those companies many look cheap, the question is – are they cheap enough to offset the risk?

These are definitely not 'widows and orphans' investments. For those brave enough to take a punt, following a portfolio approach might be the best solution. In other words, spread your cash across several mining services and contracting companies with the goal of having the  overall gains outweigh the losses from any companies that crash and burn.

Others might argue that avoiding the sector altogether is the safest policy of all.

Motley Fool contributor Mike King has no position in any stocks mentioned. You can follow Mike on Twitter @TMFKinga The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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