Boart Longyear: Dig deep or pass the hat again

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Illustration: John Spooner.

The reason Boart Longyear’s share price did not get hammered far harder than it did on Monday comes down to the extreme cyclicality of the mining services sector.

This stock is as hairy-chested a punt on an uptick in the mining exploration cycle as any. And that uptick had better come quickly.

Two years ago, Boart was tracking $US356 million in earnings (EBITDA) and a share price above $3. In the latest half, EBITDA came in at a measly $US27 million and the company is being rapidly subsumed by the interest payments on its debt.

Unlike Forge, for instance, Boart has a high-tech products division that manufactures rig equipment. That could be sold. And it is the biggest owner and hire group of drill rigs in the world by a long shot.

Still, it faces an uphill battle to survive with its equity intact. The release of Boart’s 2013 earnings on Monday paints a sombre picture.

Earnings as measured in EBITDA have all but evaporated. In the final three months of the half it managed only $US8 million.

To be fair to Boart, the December and January months are the seasonally low months. With its drill rig capacity utilisation running at historic lows, however, the outlook for the present six months is difficult. It is fair to expect that with such low capacity utilisation pricing pressure on any new contract, wins will continue to be intense.

Just last October in its management update after its emergency debt refinancing, the commitment was to achieve a target net debt level of less than one times its cyclical low in its EBITDA. The prospect of achieving this is slim given it would require net debt to be slashed by $US500 million.

A few basics: Boart is carrying about $US600 million in gross debt, its annualised EBITDA run-rate, applying the most recent half year, is $US54 million.

The group has annualised cash interest commitments of $US52 million and its normalised capex requirements – just to maintain the drill rig fleet alone – run between $US50 million and $US75 million, according to an October 2013 refinancing presentation.

It is now flagging a 2014 maintenance capex spend of just $US25 million. Management is keen to provide comfort to bond investors, that they will receive their coupon payments, though questions may be raised by the group’s competitors about drill rig fleet quality if maintenance capex is cut to the bone.

Its main rival, Canadian-based Major Drilling, although facing the same sector headwinds, is net cash and doesn’t have pesky bond-holder coupon payments to worry about.

Boart’s net debt has not blown out in the past six months as Boart has undergone an aggressive working capital release.

But the problem is that working capital can be released only once and it appears that management has already taken the low hanging fruit, having reached its goal of reducing inventory levels down to $US300 million, with December inventory standing at $US299 million.

Cost reductions are offset by pricing declines in the high single digits and continued pricing pressure seems highly likely with utilisation rates so low.

Current drill rig capacity utilisation is running at roughly 30 per cent (it was 45 per cent in the June quarter) and as pricing pressure is only really starting to bite now Boart is in a fight for its life. It has announced yet another deal on its key senior bank debt covenants – the third such renegotiation in the space of six months.

Bear in mind, this is a company that in 2009 trebled its shares on issue via a deeply discounted jumbo recapitalisation. At the time of the last recap, Boart’s shares were trading at 44¢ with the new issue priced at 27¢ ($4.40 and $2.70 in present-day terms given a 10-for-one share consolidation in May 2010).

So Boart has form when it comes to putting the hat around. It was only in October last year that the board said there was no current intention to raise fresh equity to address the highly geared capital structure.

It was effectively rolling the dice, punting on the prospect of a turnaround in market sentiment.

Now all options are on the table – including asset sales and equity raisings – in order to reduce leverage to a more sustainable level through the cycle.

This may be a bitter pill to swallow for existing shareholders, but what are the alternatives?

Will institutional investors be prepared to tip in again given past raisings, present fundamentals and the uncertainty of a near-term upswing in the cycle?

And is there enough free cash flow to service interest payments if things don’t pick up? The holders of that $US600 million in debt might be looking for a pre-emptive exit.

Management flagged on Monday’s conference call that it would not be until late March when a clearer picture emerged of how utilisation was shaping up for 2014. Having rolled the dice and taken the company to the brink, the board has some tough decisions to make come April.