After a spate of earnings downgrades, do Ausdrill’s two recent contract wins suggest the company is turning things around?
Today, 28 April, the company announced that its equipment hire subsidiary BTPE received a letter of intent from Peabody Energy for the award of a preferred equipment supply contract to Peabody’s Australian coal mine sites. BTPE will supply 68 pieces of mining equipment to Peabody mine sites in key Australian coal precincts in the Hunter Valley and the Bowen Basin. The supply will be based on a combination of dry hire and more profitable hire with full maintenance included. The contract period is for four years but is subject to annual renewals.
The contract is the biggest equipment supply contract won by BTPE since it was acquired by Ausdrill. At this stage no details have been provided on the revenue or EBITDA contribution expected from this contract, other than the company indicating that the contract will generate ‘substantial annual revenues’ for Ausdrill.
The win of a material equipment hire contract with a major resource company in the coal sector is a promising development for Ausdrill. However given the continued pressure faced by the domestic coal mining industry, in the wake of a subdued coal price, we expect the contract was competitively bid for and that margins on the contract are relatively thin. As we’ve seen with the likes of Emeco, mining equipment hire businesses have found themselves under significant margin pressure following the mining sector downturn.
In addition, last week the company announced it was awarded a contract renewal through its wholly owned African subsidiary AMS, to provide open pit mining services to Perseus Mining at one of its mines (Edikan) in Ghana. The Perseus contract is for three years with an option to extend for a further two years, and is expected to generate USD223m in revenue over five years or about USD45m per year. Arguably, this contract win was more significant to bondholders because the company relies on its US dollar revenue as a ‘natural hedge’ to support the interest obligations on its US dollar bonds.
After a period of deteriorating earnings and contract cancellations, we clearly welcome Ausdrill’s recent positive announcements. Both represent early signs of a turnaround in the company’s business. However, the landscape for the mining services sector has deteriorated in recent times. The fall in commodity prices and the associated reduction in exploration spend has led to tighter margins on mining services contracts. In addition, annual renewal provisions such as the one in the new Peabody contract give the miner flexibility to terminate contracts early leading to increased uncertainty on the future earnings stream. In a constrained commodity price environment, contract renewal or renegotiation risk will remain high.
For investors who have a high risk/return appetite and are comfortable with exposure to the mining services exposure, we continue to rate Ausdrill as our preferred name in the mining services space. The bonds are indicatively offered at a yield to maturity of 12.87%, however please note liquidity has been thin in recent times and yields may tighten given the recent good news.
The company’s performance has been buffered by its large exposure to the gold sector, a commodity which has shown price resilience reflecting its ‘safe haven’ status. Ausdrill’s corporate rating is B+ (stable outlook) / B1 (negative outlook); while the US dollar senior unsecured bonds are rated B+ / B2. Interestingly, the bonds are yielding significantly more than Virgin and are rated one notch higher. This clearly reflects the very different sentiment in the mining services versus the airline industries. Please note that, based on S&P historical default tables; B+ rated companies have about a 14% probability of default within a four year time horizon.
Please speak with your FIIG representative for more information or if you are interested in investing in the Ausdrill bond.
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