Key Points
- 1H15 revenues were slightly down (2.3%), however the significant falls in EBITDA (37%) and EBIT (63%) reflect the competitive and tough operating conditions in the mining services sector
- Impressively, Ausdrill was able to increase its net operating cashflow (up 17%) and slash capital expenditure despite these challenging conditions
- FY15 outlook is for second half year levels to be broadly in line in with 1H15, which translates to a FY15 EBITDA of around $120m
Results Summary
- Revenues down 2.3% to $413.6m
- EBITDA down 37.2% to $59.1m
- EBIT down 63.1% to $15.0m
- Statutory loss after tax and impairment charges of $177.1m
- Operating cash flow is up 17% from $65.7m to $76.9m, while capex has been slashed by 61% from $31.9m to $12.6m. Net capex has been restricted to only $9.9m
- Net debt down from $400.9m to $391.4m
- Gearing ratio is up from 34.8% to 40.4%, however this is largely due to non-cash asset impairments
Commentary
Ausdrill’s operating result reflects the ‘margin squeeze’ which is directly a result of the slowdown in mining activity and the fall in key commodity prices (such as iron ore). While revenues are only slightly down on the prior period, EBITDA and EBIT margins have been significantly impacted as a result of competitive tension/tendering and reduced demand. We note that earnings were broadly in line with analyst expectations following consecutive earnings downgrades from the company over the year. Following the 1H15 results announcement, Moody’s downgraded Ausdrill’s credit rating by one notch.
Impressively, Ausdrill was able to increase its net operating cashflow and slash capital expenditure despite these challenging conditions, generating positive free cash flow of $67m. The company has stated in the presentation that capital expenditure is to be restricted with replacement capex to recommence in 2 years’ time, so we can assume that a low level of capex (~$10m net) can be maintained over the next couple of years.
A key issue will be currency – with a number of key African contracts being terminated, the natural currency hedge which Ausdrill talks about is being eroded. The falling AUD resulted in an A$52.3m increase in the US dollar debt outstanding (which includes the bonds). This largely netted off the company’s efforts in paying down debt, with net debt only down by $9.5m to $391.4m
On balance, the payment of a $6.2m dividend was not a prudent credit action given the current climate for mining services, however it was a moderate amount overall. We also don’t think the stated continuation of meeting a dividend payout ratio is a prudent course of action from a bondholder perspective, when the business is operating at such tight margins.
We reiterate Ausdrill is a stronger credit than Emeco however the entire mining services sector continues to face significant challenges until a recovery point and this ‘uncertainty premium’ has been factored into bond prices across this sector. The company has had 3 earnings downgrades in a relatively short time-frame and is on negative outlook with both Moody’s and S&P.
Having said this, Ausdrill’s core market is gold generating about 2/3rds of revenue, which has been one of the more resilient commodities in the current cycle. To the extent gold exploration activity does pick up, Ausdrill will be well placed to win business on the upturn. However, we remain somewhat sceptical about the company’s statements of a resumption in gold exploration activity later this year, and will be looking for more concrete signs of a pick-up in activity before we start calling a recovery. We also note the 2 year restriction on capex which the company has stated (suggesting potentially a longer time to recovery than end FY15).
The discounted bond price on Ausdrill reflects market sentiment/concern around the risk of a sustained continuation of a downturn in mining activity, triggering further falls in revenue and profitability. We also see the debt revaluation as a potential key risk if the AUD continues to weaken, as this will drive up A$ leverage and increase the principal pay down needed at maturity. However, we expect the continued resilient cash flow performance and low capex can support ongoing interest payments plus a continued reduction in net debt. The company still maintains a reasonable net interest coverage (EBITDA / Net Interest) of 3.8x in the context of a cyclical downturn in a high risk industry, which remains above the bank imposed covenant of 3.0x. With a continued strong cash flow / EBITDA conversion, and very tight capex, the company is giving itself breathing space to manage its way through the bottom of the cycle.
With a net secured debt / EBITDA ratio of 0.1x, the majority of the secured debt is currently covered by cash, which provides support for a degree of recovery on the bond in default. S&P evaluates the recovery on default at an ‘average’ level of 30%-50% on the unsecured bond which is fair.
Summary
For an investor with a high risk/reward appetite, and willing to bank on a mining sector recovery pre 2020, Ausdrill may provide a speculative buying opportunity with the very high yield on offer. Having said this, we do think there remains a real risk of further earnings downgrades over the course of FY15 given recent history, that we haven’t yet reached ‘the bottom’ and are still some time away from a recovery.
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