Drilling services companies back in favour as mineral exploration booms
Pickaxe sellers, a legendary and largely extinct species, were once described as the major money-makers in mining, a title transferred in part to a new breed of hole diggers, companies selling drilling services.
The modern way of punching through the earth’s surface is essentially the same as a man with a pickaxe and shovel, only much faster and able to probe deeper with a spinning drill bit nicknamed a rotary lie detector.
History and interesting descriptions of drilling aside, the reality is that even after the most detailed geophysical analysis, such as studying magnetic and gravity images, as well as the chemistry of rock layers, the only reliable way of finding what lies below is to drill.
The rise of drilling services
Enter the companies selling drilling services which are starting to emerge from a Covid-induced flat period to be among the better stock market performers over the past few months, complete with merger and acquisition (M&A) activity.
Drillers, unless they take shares in a client in lieu of cash, are never going to deliver the bonanza profits of the exploration and mining companies which are their clients.
But the drillers are more likely to make steady profits across the commodity-price cycle because they are selling an indispensable service, and they are exposed to multiple mineral exploration programs with the search for gold and iron ore being overtaken by the hunt for lithium, nickel, copper and other members of the battery and critical metal families.
Perenti and Mitchell Services are examples of recovery
Perenti (ASX: PRN) and Mitchell Services (ASX: MSV) are two examples of the drilling company revival, having shaken off the worst effects of the Covid years when labour shortages and mobility restrictions inhibited their work with a compounding effect being that mining companies also pulled back on field activity.
Queensland-based Mitchell, which saw its share cut in half at the outbreak of Covid three years ago, has been staging what looks like a sustainable recovery over the past three months, rising by 10c (33%) from 30c to 40c – a price that values the company at $87 million.
More cautious investors should note that the latest price merely returns Mitchell to where it was earlier this year and is still well down on the pre-Covid price of 64c.
Morgans’ forecast
Morgans, a broker with its roots in the same state as Mitchell, sees a number of “upcoming catalysts” which should keep the driller’s share price moving up, perhaps to a price target of 56c.
The bonus with Mitchell, according to Morgans, is that dividend payments are expected to resume when the annual profit result is reported next month.
“The wait for Mitchell’s promise de-gearing and the spill-over of excess cash into dividends has arguably been frustrating for the market as Mitchell previously prioritised growth,” Morgans said.
“However, we think the new capital management framework and the arrival of half-yearly dividends at the August result would be a major catalyst for attracting new investors and for re-rating the Mitchell share rice off its low base.”
WA-based Perenti, which takes its name from a big Australian lizard, can trace its roots back to the more obviously-named Ausdrill, went for its own “more than halve your money” roller-coaster ride when Covid struck, falling from $1.48 to 57c.
Conditions remained tough until this time last year with an added negative for Perenti being its strong focus on gold exploration in Africa, a region notoriously difficult for mining service providers.
Perenti and DDH1 merger
The outlook for Perenti changed significantly last month when it announced an agreed cash and share swap merger with one of its main competitors, DDH1 (ASX: DDH).
The expanded business has been described by Perenti chief executive, Mark Norwell, as “highly synergistic and accretive,” delivering an estimated $22 million in cost synergies because the two businesses are a natural fit.
Of added comfort for investors wary of Africa risk, and that should be everyone, the new-look Perenti will boost its Australian exposure to a 54% market share.
Once complete after shareholder meetings and court approval expected in October, Perenti will be a globally significant mine services business operating approximately 300 drilling rigs for a client list which includes most of the world’s major miners.
The merger created a bigger business exposed to a sustained mineral production cycle which is essential to ensure mineral reserves do not decline, especially at a time of energy transition and the switch from a fossil fuel focus to battery and critical metals.
Macquarie Bank’s perspective
Macquarie Bank likes the Perenti and DDH1 deal, as it is timed to coincide with increasing mineral exploration and project expenditure, even with the ongoing risk of a skilled labour shortage.
The bank said in note published late last week that it expects Perenti share to rise from last sales at $1.14 to $1.70, adding that rising profit margins on contract drilling services had encouraged the company to upgrade guidance four times over the 2023 financial year.
“Mineral exploration and capital expenditure have increased over recent years driven by buoyant commodity prices and cashed-up miners,” Macquarie said.
“We note that the initial financial 2024 expectation for capital expenditure is higher than the initial financial 2023 point, which is supportive of the outlook for mining services companies.”