Images of giant ships lined up off the East and West Coast ports of Australia provide for a spectacular view and underlie what is turning into a generational windfall for the Australian economy.
While the major miners like BHP Billiton and Rio Tinto grab all the headlines, quietly in the background mining service companies have been building impressive gains for their shareholders.
The statistics for this mining boom look impressive. The Australian Bureau of Agriculture and Resource Economics (ABARE) forecasts production increases of 65 per cent for iron ore and 30 per cent coal; 57 per cent for Copper; 84 per cent for Nickel; 24 per cent for Uranium and 59 per cent for Natural Gas.
The Australian Bureau of Statistics (ABS) also forecast around $260 billion is to be spent nationally through 2008 to 2011 on infrastructure construction.
Also, all that heavy machinery being pushed to capacity requires maintenance which BIS Shrapnel estimates the mining sector will need to increase its spending to $4.9 billion in 2010.
As a result of the sharemarket volatility, share prices of some mining service companies have been pushed down to levels which are not consistent with the prevailing global economic realties for the commodity sector. In fact, China last week defied predictions of a sharp fall in its expected economic growth as a result of problems brought about by the global credit crunch and turned in an impressive gain of 10.6 per cent in the first three months from a year earlier.
So what are some of the things investors need to look at when assessing the best candidates in the mining services sector? Remembering that the majority of these companies service the project construction, production and ongoing maintenance phases and reflect the specialist skill sets and assets required to perform these tasks, the following should be top of mind:
1. Look for those companies who have sources of revenue which are easily identifiable. Key would be strong order books for these companies’ services.
2. Amid our current inflationary cost environment, only look at those companies whose margins are not likely to be squeezed.
3. Look for solid short to medium term catalysts such as new material contract wins, corporate activity, earnings upgrades from various stocks still in the upgrade cycle or those undertaking moderate scale share buybacks.
4. Try to avoid those companies which have flagged ongoing capacity constraints or timing issues with expected receipts of revenue. Also avoid those who are experiencing infrastructure bottlenecks, skilled labour shortages or overly exposed to a small number of large contracts.
With these considerations in mind, we believe that current share prices for some companies in the mining services sector are showing discounts of around 30 to 40 per cent to the expected growth in earnings over the next 12 months.
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Joseph Cardone is an experienced Adviser and the Branch Manager for Patersons ‘The Australian Stockbroker’ in Canberra.
Any advice provided in this article is general in nature and does not take into account the financial circumstances of any particular person. Before making an investment decision based on the above, you need to consider whether the advice is appropriate for your own personal financial circumstances.
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