Mining Service Firms Outlook: Rough Terrain

BMI View: T he pain in the mining servicing sector is far from over. A growing number of miners will preach austerity with the fading of the China-led commodities boom, pushing the global mining industry into cash preservation mode. Amidst the sharp slowdown in exploration activity, mining suppliers will suffer from a sharp reduction in order books and be forced to trim the prices of their equipment and services over the coming quarters. This should help to roll back some of the unsustainable cost pressure endured by the mining industry in recent years.

In our view, the pain in the mining servicing industry is far from over. The economic slowdown in China will continue to take its toll on demand for mining equipment makers over the coming quarters. We expect the structural deceleration in the Chinese economy to return to focus in 2014, with real GDP falling from 7.6% in 2013 to 6.7% next year.

With miners across the board pruning their portfolio and shying away from the development of greenfield projects, the global mining sector will continue its fundamental shift from 'growth-at-all costs' to capital-efficiency and cost-containment. Mining suppliers including Caterpillar, Atlas Copco and Joy Global have announced a series of earnings downgrades in recent quarters amidst the sharp slowdown in exploration activity within the mining space.

Prices Weaken, Capex Slide
S&P GSCI Industrial Metals Index & Mining Capital Expenditure

Mining Service Firms Outlook: Rough Terrain

BMI View: T he pain in the mining servicing sector is far from over. A growing number of miners will preach austerity with the fading of the China-led commodities boom, pushing the global mining industry into cash preservation mode. Amidst the sharp slowdown in exploration activity, mining suppliers will suffer from a sharp reduction in order books and be forced to trim the prices of their equipment and services over the coming quarters. This should help to roll back some of the unsustainable cost pressure endured by the mining industry in recent years.

In our view, the pain in the mining servicing industry is far from over. The economic slowdown in China will continue to take its toll on demand for mining equipment makers over the coming quarters. We expect the structural deceleration in the Chinese economy to return to focus in 2014, with real GDP falling from 7.6% in 2013 to 6.7% next year.

With miners across the board pruning their portfolio and shying away from the development of greenfield projects, the global mining sector will continue its fundamental shift from 'growth-at-all costs' to capital-efficiency and cost-containment. Mining suppliers including Caterpillar, Atlas Copco and Joy Global have announced a series of earnings downgrades in recent quarters amidst the sharp slowdown in exploration activity within the mining space.

Prices Weaken, Capex Slide
S&P GSCI Industrial Metals Index & Mining Capital Expenditure

While miners have struggled with soaring cost pressure and long waiting periods for contractors and equipment over the past years, this is set to reverse with the fading of the commodities boom. A growing number of mining suppliers will suffer from a sharp reduction in order books and be forced to trim the prices of their equipment and services in the coming quarters. This should roll back some of the unsustainable cost increases endured by the mining industry in recent years. Indeed, the boom in large scale construction projects feeding off mining has approached its peak as miners are unanimous in preaching austerity following years of chasing ever increasing production.

More Pain Ahead
Mining Equipment - Global Revenue (LHS) & Orders For Selected Companies (RHS, % chg y-o-y)

Australia: Pockets Of Opportunities

Australia's mining sector is feeling the crunch of plummeting commodity prices as a string of miners scale back their ambitions and slam the brakes on investment. Although contractors such as Transfield Services , UGL and WorleyParsons are taking hard knocks with the fading of the mining boom, we believe there are still pockets of opportunities for the mining-related heavy industry.

The crushingly low cash costs of iron ore in Australia will continue to bolster demand for drillers and shovels in the coming quarters. Compared with estimates of US$100/tonne for new entrants, major iron ore miners such as BHP Billiton and Rio Tinto are pushing ahead with a raft of expansion plans with their low cash costs of US$30-50/tonne ( see 'Iron Ore: Bolstered By Major Miners', September 24 ).

Australia In Firm Lead
Select Countries - Iron Ore Production (mnt)

Additionally, the drive towards automation in Australia is also a cause for optimism ( see 'Automation Key To Sustainability In Mining Industry', 03 April ). Mining suppliers with heavy exposure to Australia will benefit as miners in the country have been the swiftest in adopting automation technology. Apart from increasingly complex ore bodies, other factors including the shortage of skilled labour, softening commodity prices and escalating wage inflation are making the drive towards automation all the more imperative. It is estimated that mining workers in the ore-rich Pilbara region are among the highest paid professions in the world, earning around US$224,000 per annum

Select Companies - Automation Plans
Source: BMI, Various news sources
Company Details
BHP Billiton Started a trial of 12 driverless trucks at its Jimblebar iron ore mine in 2013
Opened its own remote operation center in Perth in July
Fortescue Metals Installed Caterpillar autonomous trucks at its Solomon iron ore mine in the Pilbara in October
Looking to expand and ramp up to 45 autonomous trucks over the next few years
Rio Tinto Aiming to have the world's first, fully automated, long-distance and heavy-haul rail system operating in 2015
Plans to automate about 40% of its Pilbara truck fleet by 2016
Vale Fully replacing in-mine trucks with conveyor belts
Building a second railway through the Amazon to cut costs

US: Persisting Coal Woes

In contrast to the dimming outlook in many emerging markets, we believe the core components of the US economy are on the cusp of a cyclical upswing ( see 'GDP Set To Accelerate In 2014', October 2014). With housing prices in a firm uptrend and the level of housing affordability at historical high, this will help support the expansion of the housing market and spur demand for compact equipment. Consequently, this will benefit companies such as Deere, Doosan and CNH, which together account for more than 60% of the North American compact machinery market.

Natural Gas A Watershed In Coal Industry
United States - Primary Energy Consumption by Source (Quadrillion Btu)

That said, the woes in the US coal market that many mining servicing firms have experienced of late is certainly not over ( see 'Cloudy Outlook For Joy Global', August 30). While rising natural gas will temporarily encourage higher coal burn rates, this will be insufficient to stem the overall decline in the US coal industry. The onslaught of the shale gas boom, coupled with the steady growth of wind and solar energy, suggests to us that coal's traditional dominance in the US electric power sector has passed its golden age. Furthermore, we believe that bullish industry excitement towards future US exports to Asia are overdone and the route will not be the sure growth engine that many US coal producers are betting on .

China: Outlook Dimming

We believe equipment makers with heavy exposure to the Chinese market are in for a tumultuous ride over the coming quarters. According to Off-Highway Research, China is the world's largest construction machinery market, accounting for around 31% of global units and 24% of global sales in 2012.

We expect c ompanies such as SANY and Komatsu , the largest excavator producers in China, to remain plagued by sluggish demand and falling margins over the medium term . Already, unit sales for mining equipment in China plunged by more than 33% year-on-year (y-o-y) in 2012, following a cumulative increase of 74 % between 2009 and 2011. The downshift in the Chinese economy will continue to drag on demand for mining equipment and reinforces the glut of unsold inventory in the market.

No Recovery In Sight
China - Mining Equipment Sales

Despite the recent pick-up in economic activity, our core view remains that the excessive credit-fuelled nature of China's economic expansion, particularly in the real estate sector, would eventually result in a painful hard landing. Indeed, we continue to see few prospects of a turnaround for mining suppliers operating in China. Against the backdrop of unsustainable credit expansion, f unding for construction projects will continue to be restricted by the soaring debt levels of local governments ( see 'Another Credit Binge Will Not Cure Economy', September 12 ). Moreover, as spotlighted by the accompanying chart, the Shanghai Industrials Index, made up of conglomerates that have dominated China's resource allocation over recent years, remains locked in a structural bear market.

Little Respite For Mining Suppliers
Shanghai Industrials Index

Africa: Blooming Prospects

With a string of companies from Australia, China and India expanding their footprints in Africa's mining sector, we believe the move by mining servicing firms to diversify into the resource-rich continent will be a worthwhile strategy. The wave of coal and iron ore projects scheduled to come online in countries such as Mozambique, Sierra Leone, Guinea and Botswana will ignite a surge in demand for construction equipment, especially since the mining of bulk minerals are heavily dependent on support from the heavy industry.

Work To Be Done, Before Boom
Guinea - Iron Ore Mines

However, we caution that the debilitating lack of infrastructure in Africa, along with the waning attractiveness of frontier mining, could significantly push back the mining boom that we are anticipating ( see 'Guinea Iron Ore: Pushing Back The Boom', July 11). Crucially, the cutback in mining expenditure over the past quarters has forced us to adopt a much more sombre outlook on the prospects of frontier mining. Underpinned by our downbeat view on China's growth prospects, mining companies will continue to focus on the development of their core, high-margin assets with long life potential. We believe frontier regions will be the first places where miners pull back their investment as it becomes increasingly hard to justify spending on infrastructure and other mining-related projects.

Europe: Few Bright Spots

We believe mining jurisdictions in Europe will continue to offer little upside for mining services firms. Coal mining activities in Western Europe are on the decline almost across the board, while countries in Eastern Europe and Central Asia are battling to attract foreign investment due to poor business environments, antiquated infrastructure and intermittent power supply ( see 'Europe Coal: Sluggish Production Growth As Cheap Imports Rise', August 22). Similarly, iron ore mining in Europe is set to struggle in the coming years. Weak global demand and booming supply will precipitate a prolonged decline in iron ore prices, dissuading further investment in the mining sector ( see 'Europe Iron Ore: Fading Northern Lights', August 20).

Mining Slump
Select Countries - Mining Industry Value, US$bn (% chg y-o-y)

Latin America: Mixed Bag

Despite the rich concentration of mineral veins, major mining economies such as Peru, Chile and Colombia in Latin America will fail to escape the broad weakness in the global mining industry. These countries will continue to suffer from waning capital flows into the mining space due to issues concerning resource nationalism, heavy exposure to China as well as tenuous political environment . We expect most firms operating in these countries to continue invest ing in the expansion of brownfield projects or the development of new mines for which they have already expended considerable resources ( see 'Mixed Capex Picture Across Latin America', June 19 ).

Select Mining Servicing Companies - Key Financial Data
na = not available. Source: BMI, Bloomberg. Note: Data based on latest financial year.
Company Country Market Cap (USDmn) Employees Revenue (USDmn) Net Income (USDmn) Profit Margin (%) PE Ratio
Caterpillar Inc United States 54,095 122,402 65,875 5,681 8.6 12.3
Atlas Copco AB Sweden 34,483 40,369 13,375 2,054 15.4 na
Deere & Co United States 31,569 66,900 35,657 3,065 8.6 9.3
Hitachi Ltd Japan 31,120 37,815 109,417 2,122 1.9 16.7
Volvo AB Sweden 31,005 112,311 44,859 1,631 3.6 48.9
Komatsu Ltd Japan 22,909 46,730 22,813 1,529 6.7 16.4
Hyundai Heavy Industries Co Ltd South Korea 18,897 25,378 22,254 982 4.4 14.8
Sandvik AB Sweden 17,223 47,801 14,556 1,197 8.2 17.9
Sany Heavy Industry Co Ltd China 9,507 34,887 7,396 901 12.2 18.3
Zoomlion Heavy Industry Science and Technology Co Ltd China 7,189 31,707 7,619 1,162 15.2 9.3
Joy Global Inc United States 5,444 18,019 5,661 762 13.5 7.7
Terex Corp United States 3,826 22,600 7,348 106 1.4 22.0
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