With mining commodity prices poised to push higher on the back of growing demand for metals – in particular, the “critical” minerals that are needed for the expansion of renewable energy, battery storage and electric vehicles, to meet the demands of “net-zero emissions” and the “clean energy transition” – many investors are scrambling to find the best miners to tap into these huge economic themes.
But another way to play this situation might be to look at the companies that provide services to these miners. Here are four really interesting stocks that offer great potential doing precisely that.
- Emeco (EHL, 67.5 cents)
Market capitalisation: $350 million
12-month total return: –16.5%
Three-year total return: –12% a year
Estimated FY24 dividend yield: 7% fully franked (grossed-up, 9.9%)
Analysts’ consensus valuation: $1.10 (Thomson Reuters, five analysts)
Established in 1972, Emeco is one of the leading mining equipment rental businesses in Australian mining, renting-out equipment from brands such as Caterpillar, Hitachi, Liebherr and Komatsu, on a range of timeframes and rental bases, from fully maintained fleet to customer-maintained fleet.
And Emeco does not simply rent-out the equipment: its Emeco Operating System (EOS) fleet management and mining technology platform harnesses “big data” to provide insights for the operators on the equipment to make more accurate decisions and predictions on operational performance. EOS tracks shift performance in real-time, enabling underperformance to be fixed immediately: it measures payload, dig rates, shift efficiency and machine utilisation so operators can drive productivity harder and strip costs from their operations.
Emeco listed in 2006, but has had a poor stock price performance history for most of that time; however, the company has changed a great deal over the last five years, through two transformational acquisitions. In 2017 Emeco bought Force Equipment, a national equipment rental and maintenance business, for $70 million; and in 2020, it bought hard rock underground mining services company Pit N Portal (PNP) in a deal worth $72 million. Force brought improved scale in earthmoving rental, a highly complementary fleet, and diversified Emeco’s customer exposure, particularly in the iron ore market in Western Australia through its workshop in the Pilbara. PNP brought Emeco the largest hard-rock underground mining rental business in Australia, particularly in Western Australian-based gold, nickel and base metals projects.
These acquisitions have made Emeco a much more diversified company. Four years ago, about 64% of revenue came from clients in coal mining, two-thirds of that from thermal coal used for energy production. That preponderance had obvious ESG issues in store, with all that implies potential difficulties in cost of capital, but Emeco has been able to move more into areas such as gold, copper, bauxite and iron ore. Growing gold, base metals and battery metals revenue has lifted metals revenue to 69% of group revenue, and Emeco expects further growth in hard rock and metals revenues to bring its coal revenues down toward 30% of total revenue.
From 40% of revenue in the first half of FY19, exposure to thermal coal was down to just 11% of revenue at the December 2022 half-year (metallurgical, or steelmaking coal, generated 19%). Gold contributed the lion’s share of revenue, at 36%, while iron ore accounted for 15%.
In the December 2022 half-year, Emeco’s revenue was up 15%, to $429.5 million, however earnings before income tax dropped more than 30%, leaving a net profit after tax that was halved year-on-year at just $20 million – the major culprit for the earnings fall was the troubled PNP business, but Emeco says PNP has had a “decisive reset” this year, and the successful renegotiation of the contract with nickel producer Mincor will “provide baseload earnings from which to grow the business, providing a win-win and a long-term partnership with a valued customer.”
The company has guided the market to a full-year EBITDA of $245 million—$260 million for the full year of FY23, compared to $250 million in FY22. Analysts expect earnings per share (EPS) to slide by about 7.1% this year, but rebound with 31% growth in FY24. Consensus dividend expectations for FY24 see 7% fully franked (grossed-up, 9.9%) — even winding back dividend expectations a little implies a yield bonus that flows into a fairly decent total-return reward for buying EHL.
- DDH1 (DDH, 81 cents)
Market capitalisation: $327 million
12-month total return: –11%
Three-year total return: n/a (listed March 2021)
Estimated FY24 dividend: 7.9% fully franked (grossed-up, 11.3%)
Analysts’ consensus valuation: $1.29 (Thomson Reuters, four analysts), $1.165 (FN Arena, two analysts)
Global drilling company DDH1 operates throughout Australia, North America and Western Europe, with 190 rigs, making it one of the five largest drilling fleets in the world (it is third-largest in terms of revenue.) DDH1 operates through four well-established brands: DDH1 Drilling, Ranger Drilling, Strike Drilling and Swick Mining Services (a fellow ASX-listed drilling contractor that DDH1 took over in December 2021.
The large fleet — DDH1 expects to have 193 rigs by the end of June 2023 — means the company has global scale; and it’s a modern and high-tech fleet that can add value to customers’ operations through improved productivity, but also, greater safety. Approximately 80% of DDH1’s clients are repeat business.
The fleet is split about 60% on surface drilling and 40% underground. DDH1’s drilling services are “commodity agnostic” and it has exposure to a broad range of commodities, including gold, iron ore, nickel, copper and other critical metals. DDH1 has no exposure to coal. Three of its operating brands — DDH1, Strike Drilling and Swick —are multi-commodity, while the fourth, Ranger Drilling, is an iron ore specialist.
As at the December 2022 half-year, 41% of revenue came from gold; 19% from copper’ 12% from combined gold/copper operations; 11% from iron ore; 9% from nickel; and 8% from other metals. DDH1 focuses on the less-cyclical mine development and production phases – which accounts for 85% of revenue — and has only selective exposure to more prospective earlier-stage greenfields exploration drilling. It also focuses on extending services to existing clients who have multiple mine sites – surface and underground — it does this by leveraging existing experience and understanding of the site geology, to provide drilling efficiencies to mine operators. Although Western Australia still generates the majority of revenue, DDH1 has a significant and growing presence within international markets, particularly in North America and Europe.
The global momentum toward decarbonisation and Net Zero and the resulting requirement for the “critical” battery minerals is a big tailwind behind DDH1. Not many people understand the colossal expansion of mining that will be required to supply the range (and quantum) of metals that will be needed for batteries for storage if renewable electricity and electric vehicles are going to have anywhere near the use that is predicted for them. The recent boom in exploration activity powered by a surge in spending on copper and battery metals key to the energy transition has a lot further to run – and that’s independent on increased exploration for gold miners.
For the December 2022 half-year, DDH1’s revenue rose 16% on a pro forma basis (comparing last year’s 1H22 figure, including the recent acquisition of Swick Mining Services), to $286 million and net profit increased 44%, to $28.4 million. Revenue per rig was up 6.3%, to $1.5 million. The interim dividend of 3.3 cents, fully franked, was bigger than any full-year dividend the company has paid since its 2021 ASX listing. Operating cash flow more than doubled, to $62 million.
DDH1 didn’t give full-year guidance with its interim result, and did note that revenue for January and February 2023 was affected by adverse weather events, regulatory approval delays and deferrals of client drilling programs. But it says “long-term Industry fundamentals” are driving solid demand in all of its regions of operation.
Like Emeco, analysts have whopping dividend-yield expectations for DDH1 next financial year (FY24) — it’s best not to take that literally, but factor-in some yield augmentation on expected share price gain.
- IMDEX (IMD, $2.09)
Market capitalisation: $1 billion
12-month total return: –11.1%
Three-year total return: 29.3% a year
Estimated FY24 (June) dividend yield: 2.1%, fully franked (grossed-up, 3%)
Analysts’ consensus valuation: $2.85 (Stock Doctor/Refinitiv, eight analysts); $2.84 (FN Arena, four analysts)
Mining technology company IMDEX has built-up a capability that enables drilling contractors and resource companies to safely find, define and mine orebodies with precision and at speed. The product offering is based around an integrated range of drilling optimisation products, cloud-connected rock knowledge sensors and data and analytics to improve the process of identifying and extracting mineral resources for drilling contractors and miners. IMDEX has end-to-end solutions for the mining value chain across its four portfolios; drilling fluids, drilling optimisation technology, rock knowledge sensors, and software that ties it all together. Rock knowledge is an understanding of location, texture, grade and mineralogy; it answers questions relating to where to drill next and how processing can be optimised.
As of the December 2022 half-year, rental of sensors and software on a software-as-a-service (SaaS) basis has displaced sales as the dominant (58%) source of revenue: 32% of revenue comes from sensors and software connected to IMDEX Hub-IQ (the company’s SaaS platform.
The biggest market is the Americas, from which 45% of revenue is generated, with 31% from Asia-Pacific and 24% from Europe/Africa. The product offering is “commodity-agnostic” — 50% of revenue comes from gold miners, while 35% comes from critical metals (copper, cobalt, nickel and lithium), which IMDEX says are growing a faster rate than other commodities, and it is well-placed to benefit from the necessary supply/demand rebalance. 8% of revenue comes from iron ore and 7% from other mining.
In the December 2022 half-year, revenue rose by 18%, to a record $198.8 million, growing in all regions; while normalised (excluding litigation costs not expected to recur during the remainder of the financial year) was up 20%, to $29.3 million. Revenue has grown at a compound annual rate of 13% a year over the last five years; EBITDA (earnings before interest, tax, depreciation and amortisation) has grown at 24% a year. In that time the EBITDA margin has increased from 20.2% to 31.6%.
In February, IMDEX paid $334 million for Norwegian rival Devico to gain a bigger footprint in global exploration efforts focused on critical minerals and gold. Devico is a market leader in directional drilling, one of the fastest growing segments of the mining tech market, as companies continue to look for deposits at greater depth and explore complex ore bodies (Devico is also the number two player in many sensor technologies behind IMDEX).
IMDEX says copper, cobalt, nickel and lithium historically have made up about 35% of exploration drilling spending, but as the world tries to look for supplies of critical minerals (you can add rare earths to that) that are independent of China, these metals now make up 65% of new projects; as global exploration spending re-weights as those new projects come online, the combined IMDEX-Devico business has a great market position. The critical minerals projects are characterised by being at greater depth and increasingly complex, requiring precision mining: IMDEX says those fundamentals mean that mining technology is going to be more important than ever.
This year, IMDEX also made a cornerstone (40%) investment in Canadian company
Krux, which develops advanced drilling analytics software, focusing on the collection and analysis of exploration and production drilling data in real-time. Over the next three years the remaining 60% of equity in Krux (or alternatively, Krux’s material assets including intellectual property) will be transferred to IMDEX.
The case for investing in IMDEX is strong, given that healthy commodity prices (particularly in gold and copper) give good incentive to support further exploration, while diminishing reserves need to be mined more efficiently – that’s where the company’s mining tech product suite comes into its own. Meanwhile the global commitment towards net-zero emissions means increasing demand for critical metals, and new discoveries of these are likely to be at greater depth, resulting in larger drilling campaigns. The rental/SaaS revenue is a much more sustainable business model. And as a bonus, there is a small but growing fully franked dividend yield.
- Mitchell Services (MSV, 32 cents)
Market capitalisation: $70 million
12-month total return: –16.9%
Three-year total return: –6.6% a year
Analysts’ consensus valuation: 55 cents (Stock Doctor/Thomson Reuters, one analyst); 55 cents (FN Arena, one analyst)
Mitchell Services (MSV) is a similar business to DDH1 – it provides drilling services to the minerals and energy sectors across exploration, underground and mine services, with a bias to eastern Australia; Queensland, Victoria and New South Wales in particular. That’s because, unlike DDH1, Mitchell has an exposure to coal, of the steelmaking variety. Nor does it have overseas work.
It is a family-led business, with sector experience dating back to 1959; Nathan Mitchell, son of founder Peter Mitchell, is executive chairman. In 2008, Nathan Mitchell sold the Australian operations to drilling outfit AJ Lucas for $150 million in 2008 as the mining and energy boom was in full swing. The remaining Mitchell Group operations kept to a five-year local non-compete clause, working overseas before returning to the Australian market, refloating locally on the ASX in August 2008 as Mitchell Services. The new company bought rigs as the mining boom turned to bust, growing from an eight-rig business, generating annual revenue of $15 million in FY14, to a business that today owns 100 rigs (there are 81 currently working) and generated FY22 revenue of $213.4 million.
In the December 2022 half-year, revenue rose by 17%, to a record $120.2 million, but net profit slid 83%, to $186,000. Mitchell Services has told the market to expect both revenue and EBITDA to be materially greater in FY23 compared to FY22 (EBITDA in FY22 was $32.2 million). Broker Morgans expects FY23 revenue of $241 million and a big recovery in net profit, to $3.4 million, enabling a maiden dividend of 1 cent; in FY24, Morgans projects revenue of $248.8 million, net profit of $7.5 million, and a dividend of 2.5 cents.
Just over 90% of MSV’s revenue is with global mining major companies (Tier 1 miners) — its client list includes names such as AngloAmerican, Glencore, Newcrest Mining, Newmont and South32 — and 80% of its revenue comes from work at existing mine sites, on the resource definition, development and production stages, as opposed to the more speculative activity of greenfield exploration.
The drilling work is split 53% underground, 47% surface. Gold is 55% of revenue; steelmaking coal is 32.1% (down from 44.5% in FY20), and the rest is made up of copper, lead, zinc, silver and “other.” MSV does not talk as much as its peers do about the critical metals needed for the energy transition: it says, “high commodity prices are driving continued strong demand for drilling services, particularly in the steelmaking coal sector,” although in last year’s annual report, it did cite as positives “various factors including infrastructure spending, demand for future-facing minerals, recognition of Australia as a high-quality jurisdiction in which to invest, increased budgets amongst global miners, and increased exploration programs following increased levels of capital market activity.”
Morgans says MSV “continues to trade at a stark discount to listed peers” – the broker has a price target of 55 cents on the stock.
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