This is typically a company that has been on the verge of collapse, but has somehow (mainly through debt reduction and cost cutting) managed to “transform” itself into one with exceptional profit growth.
Small cap punters like these stories because they can produce massive returns - provided they get the timing right.
Two companies your columnist has come up with that fit the turnaround bill are both in the mining services sector. This sector has been one of the outstanding performers, but for varying reasons, WDS Limited (WDS) and Swick Mining Services (SWK) have not.
Having traded close to $3 in 2007, WDS’s shares have fallen from a 12-month high of 86 cents to as low as 34 cents and are recovering at 67 cents before today.
Swick’s shares have declined almost 30 per cent since a 12-month high in January of 48 cents. They went as low as 31 cents and have bounced in the past week to 34 cents, prior to today.
WDS shares have suffered from unrequited expectations. It is a supplier of services such as pipeline and well head installation for massive coal seam gas (CSG) projects.
Key projects have not come on as quickly as the company would have liked and WDS fell victim to a common problem for those lower in the food chain of prematurely gearing up for activity.
Stepping on the gas
But two massive CSG projects in Queensland that have been given approval and are being run by British Gas (BG) and Santos and are now under way.
It is only a matter of time before WDS procures their services, according to its management:
“By 2014 BG needs 2500 wells to be drilled and today they might have 400...our company has the capability of supplying and installing equipment,” says recently appointed managing director Terry Chapman.
At this point his CFO Anne Hayes jumps in:
“The potential value for work we could be part of is $6.7 billion.”
I can hear Chapman grimacing. Controlling expectations is the key to any turnaround story.
WDS has a market cap of $100 million and Chapman is quick to point out that no contracts have been signed yet, but that his company is seeing increased “activity levels”. I suspect this might just be potential customers asking about their services.
Hayes then talks of having turned WDS into a leaner organisation by reducing debt and “restructuring” – management speak for sacking people.
This is meant to leave no doubt that when the deluge of work comes in, WDS will be able to reap maximum reward for shareholders.
A couple of brokers are taking this line. BBY, for example, rates the stock a buy and has a target price of 80 cents (almost 20 per cent above the share price).
The stock is still relatively cheap trading on a single-digit price-to-earnings multiple for the fiscal 20011 and is re-introducing dividend payments.
Drilling for wealth
Swick Mining Services is farther away from showing evidence that it’s turning around, but this means that there could be more potential to make money.
The company has a market cap of $80 million and provides underground drilling services for base metals and gold miners.
Trent Barnett, an analyst with Hartleys rates it a “speculative buy”, but wants to see evidence that the business can produce cash and live up to its potential.
His price target of 51 cents is actually below his 56 cents valuation, which are 50 per cent and 65 per cent above the current share price.
“The cycle is very strong, but Swick definitely hasn’t capitalised as well as the others,” he says, mentioning Imdex (IMD) and Ausdrill (ASL) and Boart Longyear (BLY) whose shares have all risen strongly in the past six months.
Before the financial crisis, the company impressed with its drill rig innovation. But subsequently it took on too much debt as it tried to expand into open pit drilling.
It has reduced debt but the question still remains whether it can increase its fleet utilisation. Right now that stands at 72 per cent.
Barnett says his valuation could easily grow if it wins one or two contracts in North America, where it is starting to make inroads.
“One or two contracts in the higher margin North American market would make a material difference,” says Barnett.
For shareholders, they can’t happen quickly enough.
Most of the small cap fundies I spoke to do not invest in uranium stocks.
One that did said sold out of a number on the Monday after the earthquake and tsunami occurred in Japan.
The stocks included Extract Resources (EXT), considered by many to be the best play in the sector.
His fund reinvested the proceeds into coal and gas mining companies, believing that demand for uranium will fall for some time.
He said that a nuclear plant wasn’t built in the US for 15 some years after the accident at the Three Mile Island plant in 1979.
He also said that there was nuclear capacity from decommissioned warheads.
This is something to think about in the wake of a deluge of broker reports by the likes of Macquarie, urging investors to buy uranium producers and explorers in the wake of the disaster.
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