STOCK ADVICE: TIMING IS EVERYTHING

This industry often involves crushing and processing; exactly what can happen to investors who get their timing wrong. 

ASX listed Small Caps operating in mining services often operate a commoditised business, but for investors it is important to identify an individual company’s skills and advantages. Ultimately however, it’s important to realise that it’s the size of the mining customer that determines whether the BHPs and Rio Tintos of this world can opt to come over the top and do it themselves.

So contracting is brutal business, but it can also be highly profitable, especially when you buy a Small Cap at the right price. It has the kind of operating leverage that makes you sweat – high fixed operating costs that only work when times are good – and when this works, it’s like Christmas.

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BE PREPARED FOR VOLATILITY IN MINING SERVICES

When you buy a stock like the ASX listed Small Cap FIFO operator Alliance Aviation (AQZ) at a deep discount to its net tangible assets in Christmas 2014 as a gift to your partner, you know there are low to zero expectations. It has managed to survive the financial crisis and hang in there, scrapping with the likes of BHP and Rio Tinto. The price comes off. You buy some more. You worry. That special gift will have to wait until Santa comes next year.

Then Alliance’s FIFO business leads to more general charter revenue to meet ad hoc requests, which is a positive, but not a game changer. Then what we view as a transformational deal goes largely unnoticed by the market: in late 2017 Alliance purchases Austrian Airlines’ fleet of Fokker aircraft. The acquisition of those aircraft took Alliance into the business of selling parts and aircraft and allowed it to develop additional services.

Why does it go unnoticed, because mining services is a price taking business and at Alliance there are significant cost pressures, arising from cost-cutting at, you guessed it, BHP and Rio Tinto.

MINING SERVICES COMPANIES OFTEN DIVERSIFY

This increased capacity leads Alliance into the wet lease business where it operates its aircraft for other carriers. Fast forward to today and the company is now delivering regular scheduled public transport services to regional airports.

Things are looking up. Then, bang, Qantas takes an almost 20% stake at the beginning of February. The stock is now trading at more than four times those prices back in late 2014 and you buy your family a new car. It’s all for them.

If you are interested in learning more about the mining sector and how to invest in this area, read more here.

SHARES TO BUY: SHOULD YOU BUY A MINING SERVICES STOCK FOR YOURSELF?

We like the ASX listed Small Cap MMA Offshore (MRM) although there is quite of bit of risk attached. The company services the oil and gas industry with its fleet of specialist shipping vessels in Australia, New Zealand, the Middle East, South East Asia and Africa. You won’t get crushed by this stock, but the risk is, you might drown. The company is trading at a 50% discount to its NTA, which reflects the tough operating environment, due to an oversupply of vessels, largely arising from oil and gas fracking in North America.

MMA’s stock received a much needed boost this month after an upbeat presentation saw the company confirm FY19 operating earnings (EBITDA) guidance of $27m, up 67 per cent on FY18. The company is seeing good signs of recovery with a number of major oil and gas projects under consideration. Industry consultant Rystad Energy is also positive on the long-term outlook although, vested interests aside, I’m conscious of the long lead times for investment in the sector and the lag in higher demand for ships.

A SMALL CAP STOCK NOT FOR THE FAINT OF HEART

Although one key operating metrics – ship utilisation rates – is improving, charter rates are at less than half their historic levels and there is oil price and financial risk. The balance sheet is much better than it was a few years ago post the $100m equity raising and fleet rationalisation, but its debt metrics need to keep improving.

What it does have is operating leverage. A key profitability measure is its return on assets: the ships’ operating earnings (EBITDA) divided by the value of the fleet. This has doubled in two years but is only just over 4%, well below historical levels – which averaged 15.6% over FY10-FY15. An ROA of around 15% would generate an operating EBITDA of around $83m, almost three times the current level.

Look, we didn’t say we were offering you a quiet Christmas. If it works out, you might want to hedge your bets and buy an electric car, though probably not a Tesla – too much risk.

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