Labour costs are continuing to inflate around the country while miners are buoyed by high commodity prices. So where dos that leave mining services companies?
Chief Investment Officer, Steve Johnson, talks to Forager Australian Share Fund (FOR) senior analyst, Alex Shevelev, about the Fund’s investments in mining services companies Macmahon (MAH) and Perenti (PRN):
Hi and welcome, it’s Steve Johnson here, Chief Investment Officer at Forager Funds and today I’m talking mining services stocks with Alex Shevelev. We spoke in a recent video about a tech sell off this year not having a huge impact on the portfolio, but there’s another sector we are invested in where there’s another sell-off going on and that’s mining services.
So 4% of the investment portfolio is invested in McMahon and Perenti, two mining services companies that help miners to move dirt around, operating in various jurisdictions both in Australia and overseas.
The global economy is recovering quite rapidly. Commodity prices are up and investors are throwing plenty of cash at companies to build new mines. I would have thought that was all pretty good for mining services companies.
That was the original thesis. Steve, in this case unfortunately, the labor costs have become a big focus. So Perenti was out last week with a downgrade to earnings expectations on the basis of labor being more expensive and being harder to get.
So, we’ve had cost inflation impacting these businesses. We’ve owned McMahon for some seven or eight years. It’s a notoriously difficult sector to invest in because these types of things happen with some regularity, and it’s probably true across contracting businesses in general. I think any business where you bid a price upfront, that assumes that the world is mostly going to be okay, most of the risks are to the downside in these types of businesses.
That’s right and if you’re in a position where you are bidding a fixed price for an amount of work that is going to be troublesome over the next six, twelve months and out to two or three years. The interesting thing with these specific mining contractors, both McMahon and Perenti, is that their relationships with the miners are such that as those costs rise, they’re able to pass those costs through to the miners.
That entails a lag and thus the most recent downgrade, but we’ve got six months here of difficult margin pressure. Out the other side of that though, we still have those factors you talked about before. So we’ve got a lot of work going on and those mining services companies are in the running for a lot of very large contracts that should start to translate into earnings closer to 2023.
Now Perenti’s share price halved, McMahon’s down by a third or so. They’re certainly not priced like there’s a recovery to earnings coming in the medium term I assume.
They’re not, both of those names are trading at five to six times earnings in 2023, a slightly higher multiple of 2022. There was a case of shoot first on the expectations of lower near term profitability and ask questions about profitability in the long-term later.
As I said, we have been shareholders for a very long time. We have very modest expectations about these businesses, but at the moment, they are priced for worse than modest expectations for a depressed level of earnings to continue for ever. It’s an interesting space for the portfolio, but one that we will keep in very modest size due to some of those limitations about these businesses ever working out too well on the upside. Thanks for tuning in.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.