Drilling prices ‘not sustainable’: Major Drilling

Prices for drilling services have reached levels that are too low to be viable in the long term, said Francis McGuire, president and CEO of Major Drilling Group International (TSX: MDI), in the company’s most recent financial statements — perhaps suggesting a market bottom.

Major Drilling reported a net loss of $7.3 million, or 9¢ per share, in its most recent quarter, ended July 31.

Amidst a continuing downturn in the mining sector and lower demand for exploration and development drilling, the company saw its revenue decline 38% to $67.6 million in the first quarter of fiscal 2015, from $108.2 million a year earlier. Gross margins declined to 24.7% from 38%.

“In the quarter, revenue and margins reflected the impact of the lowest pricing we have seen in fifteen years,” McGuire said.

“These levels of pricing are not sustainable beyond the medium term, as it will affect the capacity of the industry to maintain the quality of its equipment.”

Part of the decrease in pricing is due to the focus on cost-cutting among senior mining companies, McGuire said. That makes them more likely to defer specialized drilling projects — which are “more expensive by nature.”

With decreasing prices and margins, Major Drilling is struggling to improve productivity beyond the changes it has already made in the past 18 months. The company has already restructured its operations, including a shutdown of its Australian branch in the previous  quarter.

Business was down in all regions for the most recent period: revenues fell by 32% to $36.4 million in Canada and the U.S. (although the decrease came wholly from Canada, as Major’s U.S. operations held steady); by 35% to $14.1 million in Central and South America; and by 49% to $17 million in Australia, Asia and Africa, owing largely to Major’s Australian branch closing and political uncertainty in Mongolia.

To diversify its business, the company recently bought Taurus Drilling Services, a North American-focused company offering underground percussive and longhole drilling, for $27.7 million in cash, shares and the assumption of debt. With the purchase, Major acquired 39 drill rigs, related equipment and inventory, and contracts, as well as management and staff.

“The Taurus acquisition opens the door to additional diversification in the mining industry, as percussive long-hole drilling is more related to the production function of a mine,” Major Drilling president and CEO Francis McGuire said when the deal was announced in July.

“Offering both underground production drilling and our existing underground core drilling, we can now provide an even wider range of complementary services to our clients.”

CIBC World Markets analysts Kevin Chiew and Cosmos Chiu saw signs of an impending end to the mining downturn in Major’s quarterly results.

Although Major Drilling has been cautious in predicting the timing of a recovery, Chiew and Chiu interpreted the company’s comment that pricing levels are unsustainably low and the fact that drill-use rates have declined to an unheard of 25% — as evidence the industry is at, or near, a bottom.

“We do not expect a meaningful turnaround to materialize in the near-term, absent a significant improvement to the metals market [especially gold and copper],” they commented in a client note. “What we believe is needed to spur on a recovery for the drillers are higher metal prices, and in particular gold prices, to draw in renewed interest to the space and open up a financing window to the junior and intermediate mining companies.”

The analysts, who have an $8.50 price target on Major Drilling, describe the company as a “market leader” that has shown both a willingness and an ability to adapt to changes in the business environment by expanding into new areas (Brazil) and into commodity-specific areas (energy).

They also praise its balance sheet, which is debt free and held a net cash position of $42.8 million at the end of the quarter, in comparison to its rival Boart Longyear, which has a US$555-million net debt.

Major Drilling shares recently traded at $7.69 in a 52-week window of $6.75 to $9.78. The company has 80.1 million shares outstanding.