Boart Longyear: An Undervalued Giant of the Drilling Sector
The company conducts these activities through two operating divisions, known as the Global Drilling Services and Global Products divisions. The Global Drilling Services division operates in over 40 countries. It provides services and offers a range of drilling technologies, including diamond core, underground, reverse circulation, rotary and sonic drilling. The Global Products division manufactures and sells capital equipment and consumables primarily to customers in the drilling services and mining industries globally. These products include rigs and products such as bits, rods and in-hole tools for exploration drilling, rock drilling and environmental, infrastructure and construction applications.
The company trades in the Australian stock exchange in Sydney under the ticker BLY.AX.
BLY has a broad service offering that allows it to offer a complete range of drilling capabilities. This gives the company an advantage in contracting with major mining companies globally like BHP Billiton, Rio Tinto, Freeport McMoRan, etc. However, price is another determining factor for several companies primarily for junior or intermediate ones when they select a drilling services provider. This is why BLY's price fell significantly lately, but it is a buying opportunity at the current levels of A$1.44 as will be further analyzed below. Simply put, the market has overreacted.
BLY pulled in $1.1 billion in revenue during the first six months of 2012, up 15 percent from the same time last year. Earnings before interest, taxes and other items were $208 million. That was 26 percent higher than in the first half of 2011. The company’s net profit was $97.7 million, a 32 percent gain from the January-through-June period of the year before.
Based on my estimates, the current market cap of BLY is 0.3x the annual revenue for fiscal year 2012 and 3x its FFO annualized for fiscal year 2012. Boart also trades at a PBV of 0.5 currently. The long-term debt is 0.4x the stockholder equity and around 2x the FFO annualized. I also estimate BLY to have a 2012 P/E as low as 4.
The gross margin hovers at 28% and the EV/EBITDA ratio is 4.
Boart Longyear Ltd. announced an interim dividend of USD0.064 per share for fiscal 2012 (fiscal year 2011: USD0.048 per share). I expect the total dividend yield to be higher than 6% for fiscal year 2012.
Diversification is an important feature of BLY. No customer accounts for more than around 5% of revenues and no single contract accounts for more than 2% of revenue.
As of the latest news, the company ousted the CEO Craig Kipp who was unable to calm restive shareholders and reverse its slumping stock price. The immediate termination of Kipp was unexpected as he said, "I guess that’s it, even though we are expecting to have record performance this year. It was somewhat of a surprise." "It was primarily due to the stock price," Boart spokeswoman Monika Portman said, adding that Kipp’s strategies to make the company more profitable and increase its appeal to investors hadn’t panned out. She said Kipp did not resign. "All of these actions never really moved the stock price, and the board just felt it was time to move on," Portman said.
The new CEO is Boart Longyear's chairman, David McLemore. A search for a successor to Kipp is underway. In these roles McLemore will be supported by the business' senior leaders, including Alan Sides (Products), Joe Ragan (CFO) and Mike Birch (Drilling Services). McLemore has extensive operating experience as chief executive of service and manufacturing businesses and has been a director of Boart Longyear since 2005. In addition to reviewing the strong internal candidates for CEO, the board will conduct an external search to ensure the company has the best possible individual to succeed Kipp.
It must also be pointed out that three separate directors purchased shares in the company in September 2012.
The recent drop of the share price
Even though the financial results during the first half of 2012 were a "record," Kipp had announced in August that the company was revising downward its expectation of second-half revenue and EBITDA earnings. He cited "global uncertainties," including Europe’s debt crisis, slowing growth in China, restrictive financing conditions and the U.S. elections. Revenue and EBITDA would be "more in line" with 2011 results, he said. His comments spooked shareholders, who had already been backing away from the stock. From April to August, Boart shares had lost close to half their value. After Kipp’s remarks, the stock plummeted to A$1.11 a share which is a record low for the last two years.
Back in February 2012, Boart Longyear Ltd. announced that for fiscal 2012, it expects revenue of USD2.3 billion and EBITDA of USD460 million. According to I/B/E/S Estimates, analysts were expecting the company to report revenue of $2.2 billion and EBITDA of $425 million. However the former CEO updated this guidance recently to lower levels and made it more in line with 2011 results. The new CEO has not released any new guidance thus far. The full year 2011 results were:
-Revenue of US$2.02 billion, up 37% over full year 2010.
-EBITDA of US$356 million, up 60% over full year 2010.
-NPAT of US$160 million, up 89% over full year 2010.
-Earnings per share of 35.1 US cents, up 89% over full year 2010.
-Return on equity (ROE) of 14%, up 75% from 8% ROE recorded in 2010.
As of the latest updated guidance, BLY believes that the major mining companies will pare back on their exploration drilling budgets in the second half of the year due to shareholder pressure to preserve capital. The difficulty that mid-tier, or junior, mining companies have in raising equity capital will provide further pressure on exploration spending.
Reasons for the upside potential
1) The company has done the right thing downgrading guidance, to meet continuous disclosure obligations and to set the bar low. The cautionary outlook of the prudent management is the right thing to do in the current environment with the global uncertainties. However, the management have been quoted recently in some broker research saying they have been told by their clients (resources companies) to prepare for 2013 as if it is 2012. This would imply the company is very cheap (share price) currently even if there is zero growth moving forward to 2013.
2) The Chinese growth seems to pick up steam after the recent data and thus this props up demand for commodities. In other words, the demand does not seem to slow down significantly for the coming months. China’s manufacturing sector has showed signs of improved health in October, adding to the evidence that the world’s second-biggest economy is stabilizing after two years of slowing growth. HSBC’s flash China manufacturing purchasing managers’ index (PMI), the earliest indicator of the state of factory orders in the country, moved up to 49.1 in October, from 47.9 in September. A slew of economic data released over the past two weeks – from a 10% rise in exports to a big jump in money supply – suggests that the economy could stage a moderate recovery in 2013. According to the HSBC economists Sun Junwei and Qu Hongbin, the producers have started to increase prices in steel and cement in recent weeks on the back of increased construction activity. In addition, the price of gold is almost double what it was in 2008, the price of copper remains relatively high by historical standards, and both are well above average costs of production.
3) The mineral projects are getting deeper and more expensive worldwide as the "low hanging fruit" and the low cost mineral resources have already been picked up a long time ago.
4) Boart is the world's largest drilling company, so it is a leader in its sector. This should give it a premium versus its peers. In addition, new services were added recently as the company:
a) It expanded its down-the-hole (DTH) bit options by releasing 18 new product configurations that are compatible with over 26 third-party DTH hammers. These additions enhance the already extensive list of Boart Longyear percussive bits that can fit third-party DTH hammers.
b) It opened up recently one more "First Parts and Service Center" in Salt Lake City of America due to a high density of Boart Longyear customers in the area. The facility is 20,000 square feet. This includes a 15,000-square-foot shop and 5,000 square feet of office space. The parts and service center provides aftermarket equipment support for Boart Longyear's third party customers in the mining industry through technical support, repair and rebuild services, preventive maintenance, and training programs. Drilling contractors use these services to increase productivity and to reduce downtime of their drilling equipment. The Salt Lake City location adds to the existing parts and service centers in Adelaide, Australia and Nottingham, United Kingdom. The global expansion of the Boart Longyear parts and service centers also includes the further development of the North Bay/Ontario and the Lima/Peru markets. These markets will be upgraded to full-capacity parts and service centers. More openings are also on the way as Boart Longyear will also be opening new parts and service centers in Santiago/Chile, in Belo Horizonte/Brazil, in Johannesburg/South Africa and in Khabarovsk/Russia by the first quarter of 2013.
c) It launched GTUMX Diamond Coring Bits in Oct 2012. The GTUMX™ diamond coring bit as the latest addition to the their award-winning Ultramatrix™ (UMX™) line and it targets primarily the South African market. The GTUMX is designed for shallow holes and conventional drilling for both exploration and geo-technical applications. The ability to drill faster with high penetration rates and to outperform existing bit technology in a wide range of ground formations makes the GTUMX ideal for customers seeking an affordable alternative to their current bit selection.
5) Boart is also a dividend payer and it attracts not only value investors at the current levels but also income investors who are reaching for yield. Even if there is zero growth in 2013, the dividend looks quite sustainable for the next couple of years to say the least.
BLY competes mostly against regional and local contractors. There are also few Canadian companies like Major Drilling (MDI.TO) that compete with BLY. Layne Christensen (LAYN) is also a publicly traded American company which has a significant mineral exploration and drilling division, so both LAYN and MDI.TO could be used as a reference point to BLY's valuation and metrics.
LAYN has rising Revenue year over year, but its bottom line has not always been profitable in 2012 due to discontinued operations and one-time charges. The current market cap is 0.3x the annual sales for 2012 and more than 10x its FFO annualized for 2012. Layne also trades at PBV of 1 currently. The long-term debt is 0.25x the stockholder equity and approximately 3x the FFO annualized.
The current market cap of MDI is 0.8x the annual revenue for fiscal year 2013 and 4x its FFO annualized for fiscal year 2013. Major Drilling also trades at a PBV of 1.6 currently. The long-term debt is 0.08x the stockholder equity and 0.25x the FFO annualized. MDI has an estimated PE of 7 for fiscal year 2013. Fiscal year 2013 for MDI started in May 2012.
The global slowdown can drive commodity prices (gold, copper, iron ore and other base metals) significantly lower resulting in a slump of the exploration spending worldwide. If the mining industry gets weak and the mining boom is over, then it will most likely lead BLY to burn cash and increase its debt levels.