The old share market saying “buy stocks when everybody else is selling” is hard to put into practice. Mining services companies are a good example. After being smashed this year, a few look like good value; most are value traps that could still crunch portfolios.
Investors could not get enough of mining services stocks in 2010 and 2011 as Australia’s staggering resource investment boom peaked. Then commodity prices fell; several large mining projects were deferred or cancelled; and big resource companies sought cost savings from service providers.
The result was a sea of earnings downgrades from mining services stocks in 2012-13, and tumbling share prices. Former market darling Monadelphous Group slumped from a 52-week high of $28.48 to $17.54, and Forge Group fell from almost $7 to $4.18.
Then there were disasters such as Boart Longyear, down from a 52-week high of $2.38 to 40 cents. Several smaller mining services stocks are also down 70 to 80% from their price highs, and the carnage continued this month with Ausdrill announcing a profit downgrade and Forge expected to follow (it was in a trading halt as this newsletter published).
The Forge news was particularly troubling, given problems from two of its key projects – and their possible effect on FY14 earnings – were not flagged at the annual general meeting, only weeks earlier.
The potential for nasty profit surprises – and highly dilutive capital raisings – reinforces the dangers of investing in the troubled mining services sector, and questions whether governance, generally, in the sector is keeping pace with the magnitude of earnings risks.
The Forge trading halt was also a brutal, timely reminder that the unwinding of the resource investment boom has a long way to run, and that mining services stocks, which look cheap on average, can get a lot cheaper yet.
But every stock has its price. Forge, for example, now trades on forecast Price Earnings (PE) of about 5.7 times, according to consensus analyst forecasts, although earnings risk is high. Resource project accommodation company Decmil Group is on 7.6 times. Ausdrill has a forecast PE of 4.8 times 2013-14 earnings.
Cheap? Maybe. A buy? No. For one thing, the E (earnings) in the PE equation has high uncertainty for most mining services companies, given the risks of further resource project cut-backs. In fact, it’s hard to think of any share market cohort with lower earnings visibility right now than mining services.
Moreover, mining services stocks are not great long-term investments at the best of times. These companies typically have high fixed costs, high working-capital requirements, and are prone to having expensive equipment sitting idle and depreciating rapidly when demand slows. They are not set-and-forget investments for long-term investors, such as self-managed superannuation funds, and need to be traded through the mining investment cycle.
Caveats aside, the best opportunities usually emerge when investors give up on sectors. For all the gloom, there have been a few stellar mining services stocks: Clough surprised the market with earnings upgrades and should be fully acquired this year. A new player, accommodation provider Titan Energy Services, turned heads with stronger-than-expected profits and a soaring share price.