Macro Investor: Mining services whimpers

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By Chris Becker

Over the weekend, reports continued to emerge following BHP-Billiton’s (BHP) announcement of a large impairment charge on its US shale gas assets on Friday, that expansion plans in the Pilbara will be put on the backburner. CBA analysts first reacted by cutting earnings forecasts at BHP – but this already looked priced in – as confusion reigns over strategies for its megaprojects.

The Cupboard has a broader piece out this morning:

BHP Billiton’s savage writedown of its US shale gas assets has raised the prospect of further billion-dollar impairments in other parts of the business, with the group’s struggling aluminium operation in the spotlight before the full-year results in two weeks’ time.

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Whilst these impairment charges will undoubtedly affect BHP’s robust balance sheet, the more interesting dynamic is the flow-on effects to mining services companies. Particularly, those involved in capital expenditure (capex) planned projects, not operational expenditure (opex) on completed projects.

A new door of The Cupboard, but with old hinges, News Ltd’s Business Spectator, is also out with a piece fueling the speculation:

…staff redundancies follow reports that BHP iron ore boss Jimmy Wilson had told staff the miner was reviewing its Pilbara growth plans in the face of “substantial” cost escalations and weakening commodity prices.

The mounting signs of spending pullbacks in the Pilbara only add to speculation that BHP is moving closer to delay the $US20 billion ($A19 billion) development of a new harbour at Port Hedland which is intended to underpin an overall widespread expansion of BHP’s Pilbara operations.

A number of engineering firms ― including GHD, Fluor, Sinclair Knight Merz and Calibre Group ― have reportedly made staffing cuts and redeployments in the face of the growing likelihood that BHP will cut costs and defer growth plans.

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Given the falls in the material sector and particularly the market darling twins of BHP and RIO (which reports later this week), and with our preceding research already pointing to such risks to the capex space, Macro Investor last week canvassed an opportunity in this dynamic:

The decelerating growth rates reflected in lower prices for key commodities such as iron ore and coking coal, Australia’s terms-of-trade position has also suffered, as have local markets across the region….

As uncertainty also continues about a credit crunch emanating from a European break-up or sovereign debt disaster in Spain and as new supply from Africa and South America comes online, Australian mining companies are understandably nervous, cancelling or delaying project starts where previously they were bullish. This has been reflected in mining company shares and, to a small extent, the Australian Dollar, but mining services firms, which stand the most to gain and lose from the status of mining construction projects, are still in many cases riding high. We expect recent falls in bulk commodity prices to flow through to material capex retrenchment in medium term…

….Of course, the size, timing and composition of potential stimulus is unknown and as such we are advocating a hedged pair trade, not a full-blown directional one despite the now attractive valuations of many mining companies. By having a foot in both the bearish and bullish camps on commodities and China we aim to capture returns from the slowing in mining investment plans, as well as hedging China’s medium term stimulus.

You’ll have to sign up for a free trial to read the stocks and strategies mentioned (Ok, we analysed BHP as well here) – but there are more opportunities in the days and weeks ahead as earnings season mounts up. Eighteen companies this week, including mining services companies Bradken (BKN) and Leighton (LEI), with Rio Tinto (RIO) in between, which should make for an interesting start to the new financial year. What fate lies for mining, not just the extractors, as Australia’s key exports – coal and iron ore – continue to slide?

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Chris Becker is an investment strategist at Macro Investor, Australia’s leading independent investment newsletter covering stocks, trades, property and fixed interest. Each week Macro Investor publishes tables on the top ten most undervalued and overvalued stocks on the ASX. A free 21-day trial is available at the site.

You can follow Chris on Twitter.

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