Mining investment has not yet reached the bottom – signalling more pain ahead for mining services companies.
That's according to the Reserve Bank of Australia's new governor Phillip Lowe. In his opening speech to the House of Representatives Standing Committee on Economics, Mr Lowe said, "While mining investment still has some way to fall, our estimate is that around three-quarters of the total decline is now behind us."
That could be either good news or bad news for construction and engineering firms like Monadelphous Group Ltd (ASX: MND), Bradken Limited (ASX: BKN), Ausdrill Limited (ASX: ASL), Maca Ltd (ASX: MLD) and RCR Tomlinson Limited (ASX: RCR).
It could mean that the sector is through most of the rough patch and that a recovery is ahead. It could also mean that revenues and earnings are still going to fall in the short term.
That's fairly evident when you consider Monadelphous' annual financial results over the past five years. Revenue growth is going backwards and accelerating as are profits as the table below shows. As good as Monadelphous' management have proven themselves to be, the waves sweeping through the sector are affecting even the best companies – and there's not much that they can do about it.
| 2012 | 2013 | 2014 | 2015 | 2016 | |
| Revenues | 1,897.5 | 2,614.1 | 2,329.6 | 1,865.0 | 1,364.7 |
| Net profit | 126.0 | 156.3 | 138.6 | 105.8 | 67.0 |
| Margin | 6.6% | 6.0% | 5.9% | 5.7% | 4.9% |
| EPS ($) | 1.42 | 1.73 | 1.50 | 1.14 | 0.72 |
| Dividend ($) | 1.25 | 1.37 | 1.23 | 0.92 | 0.60 |
| revenue growth | 37.8% | -10.9% | -19.9% | -26.8% | |
| profit growth | 24.0% | -11.3% | -23.7% | -36.7% | |
| margin growth | -10.0% | -0.5% | -4.6% | -13.5% | |
| dividend growth | 9.6% | -10.2% | -25.2% | -34.8% |
Source: Company reports
From an 11% fall in revenues in 2014, to a 20% fall in 2015 and a 27% fall in 2016, 2017 could be even worse and likely to magnify the fall in net profit as well.
Other mining services companies didn't fare as well. Maca saw its net profit more than halve in 2016, falling from $54.4 million to just $24.2 million. RCR Tomlinson saw its underlying net profit sink from $51.4 million in 2015 to $20.1 million.
The problem for investors jumping into mining services companies now is that the current dividends are likely unsustainable. Monadelphous has cut its dividend each year of the past four years and 2017 is likely to be the fifth consecutive year.
That's why the current dividend yield of 7% at the current price of $8.63 is misleading.
Foolish takeaway
Trading on a P/E of ~12x, Monadelphous doesn't appear cheap enough to compensate investors for the almost certain plunge in earnings and dividends in the 2017 financial year. Beyond that, we could begin to see a recovery in the sector.
