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Life at the bottom

09 Feb 2009

By Richard Roberts,  (Article from HighGrade.net, 9 February 2009)

As another bearish mining service sector missive was fired by a former market bull and ASX-listed engineer Sedgman put a “minimum of 12-18 months” estimate on the duration of the downturn, HighGrade asked Alan Fenelon, Tony Sheard, Jun Cowan and Mark Warren how “new” ventures were faring in a tough market.

“It’s life ... but not as we knew it” – with apologies to the Trekkies out there – pretty much sums up their responses.

Fenelon recently joined Minetec Communications as CEO after a stint as a senior manager with Australian mining software company Micromine. Sheard became a stakeholder in specialist engineering firm McSweeney & Partners (now MSP Engineering) pre-GFC and is now the company’s chief financial officer. Cowan oversaw the rapid market entry of the Leapfrog 3D geological modelling software with Zaparo before starting up Prestologic last year. And Warren, along with some senior colleagues from Snowden, opened the West Perth head office of a new mining consultancy, Optiro, last August.

While Minetec, MSP, Prestologic and Optiro all have some of the world’s biggest miners as customers, they are small firms and arguably among the vast supply sector’s bottom feeders. Of course, they have ambitions to grow.

What Fenelon, Sheard, Cowan and Warren most have in common is that they went into their ventures with a very different view of the future – at least the near future – to the one they have now and have had to adjust accordingly. But while business confidence in Australia is reportedly down, okay, at rock bottom according to the latest surveys that measure such things, it is fortunately not in short supply among the four mining service sector leaders.

“I wouldn’t say it [the mine communications business] is recession proof,” said Fenelon. “But the services we are providing at a site level are still critical, so while the site is still alive and doing things our service contracts are still alive, effectively, and we’re still a critical part of the mining operation.”

Minetec, which has service contracts with the likes of Fortescue Metals Group, BHP and Thiess, has seen its service and product business slip from six months ago and it has reduced its workforce by 3-4%, according to Fenelon. “We anticipate that will be the end of our headcount reduction. And in fact we’re hiring on the commercial side of the business [and] building up that team as we speak,” he said. “We’ve done pretty well even without being commercially over-aggressive over the last couple of years, as everybody else has I suppose. While there is a slowdown I’m pretty hopeful that if we start being more proactive and going out to secure the business aggressively we’ll bring our numbers back up to where they were six months ago.”

Sheard is a figure working behind the leading lights at MSP, Peter and David McSweeney, the sons of company founder John McSweeney. Peter is the managing director and David, who has run several public junior exploration and mining companies, the chairman. Another experienced WA mining executive, Craig Burton, has also become a key stakeholder in MSP. Sheard became an MSP shareholder in 2007 and then CFO later that year. He said the company had been kept busy for many years by work offered to Peter McSweeney, because of his reputation in the industry, but after an ownership restructuring and expansion it was now chasing a broader range of engineering work and seeking to grow organically.

MSP (see separate report this edition of HighGrade) now has more than 30 dedicated professional and para-professionals including process, mechanical, structural, civil and electrical engineers, design managers, draftspersons, project managers, construction managers, supervisors and project controllers, and its shareholders include some experienced consultants who have worked alongside but not with McSweeney over a number of years, including structural design principal Jeff Welch, electrical design principal Scott Bonser, and construction project manager Daren Tetley.

“Over the last two years we’ve gone from a business with 7-8 people involved to, I think we peaked last year at around 50 and that’s now around 30-35,” Sheard said.

“We were very much constrained last year because we just couldn’t recruit engineers and this year, even though we’ve had to be more active in terms of generating our order book and projects, certainly on the recruitment side of things and being able to get technical resources, it’s been a lot easier.

“Because of where we are placed, we’re reasonably positive. We’ve got a lot of exposure to industrial minerals and gold, which are less impacted by the downturn, and we’ve gone from being basically a service fee company undertaking project management to now being a full design and construct firm with an excellent delivery team.

“Our basic business strategy is to focus on fewer projects that we believe have a high likelihood of conversion to construction. It is based around client relationships and really helping the client take those projects right from scoping through pre-feas, feas, bankable, and then design and construction. Complementing that is our continuing work with brownfields clients.

“We’re coming from a small base – there are not a lot of competitors in the market for the size of projects that we target, which is at this stage effectively $A25 million and under, so we think we’re well placed to continue down a reasonably strong growth path, albeit it might flat-line for anything up to 2-3 years.”

Dr Jun Cowan, who seven years ago turned a rapid 3D interpolation technique developed by a New Zealand firm into a rapid drillhole data modelling tool that would “leapfrog” existing geological modelling methods, estimates hundreds of Leapfrog software licences have been sold since the product was launched at the end of 2003. He formed Prestologic last year as a geological modelling consultancy and Leapfrog sales and training agent in Australasia and Africa.

Cowan believes the attributes of the product are the key to his survival and future growth.

“Is Leapfrog recession-proof?  I think so, mainly because it can do so much more in such a short time compared to traditional geological modelling programs,” he said.

“Take for example my 3D model of the Boddington data built with Leapfrog. There is so much information in the drillhole data acquired by Boddington Gold Mines [nearly 6000 holes and more than 1000km of drill-hole data] that it has been virtually impossible to build a complete 3D geological model from this dataset until now.

“The multiple geological models that can be achieved with Leapfrog simply cannot be replicated by other software products, so effectively Leapfrog has no competition.

“There may be a temporary down-turn in the number of licences that are renewed mainly because some companies are cash-strapped. However, I have not seen a marked slow-down in the signing up of new companies to using Leapfrog or slow-down in renewals. Now that companies are tightening their belts, and they want more bang for the buck from software, so I think Leapfrog is positioned to take advantage of this.”

Warren also sees a unique combination of skills and experience, and the focus of the Optiro consultancy business on optimisation and business improvement, literally, from the ground up, as pluses for the fledgling group.

“We started in August [last year],” he said. “We’ve got to be prudent ... so whereas I had planned in the first year to run up to around 30-35 people, we’re now going to stay around the 15-20 level for now. But it suits our style of business because it is very much a strategic advisory firm. We don’t really want to do a lot of the bums-on-seats more junior type of work that you will see other consultants do – some of them do – which involves a lot more people.

“We’re happy to manage others doing that, but given that we’ve probably got more grey hair, or no hair, on average than other firms, it leaves us in a position where we are people who can sit at the top of it, run the process and provide that strategic advice. That was the basis behind Optiro, and why we have the name.”

Warren said he remained confident about the future despite the rapid clampdown on expenditure by mining and exploration companies.

“Some of the bigger consultancies might have a better spread [of work] but they’ve also got bigger overheads and if they’re not watching that at the moment then they’re not sensible,” he said.

“Obviously when we started we didn’t realise this [rapid downturn] was going to be happening. But even though there’s a downturn, which means you’re fighting for less work with everybody else, the upside is that the whole premise of our business was about optimisation and risk management. We have the people with the experience, and who think outside the box, they’re operationally based and they’re good at optimising.

“Pretty much every client that we go out and speak to absolutely loves the business model and we’re getting a lot of praise for that, which is good. But it’s in tough times.”

A former resources bull but now someone seemingly becoming more ursine with each passing week is Southern Cross Equities market analyst Charlie Aitken, who says the “business investment/capex tap is fully off” and it is hard to say when it will be turned back on.

“As credit remains tight and the deterioration in world economic growth accelerates, the global business investment and capex cycle continues to decline alarmingly,” he said.

“The halving of Chinese growth and the 50+% falls in commodity prices have rendered marginal mining projects, and some capacity expansions, as simply uneconomic. Currently industry estimates reveal that some 130 mining projects worldwide worth $210 billion are expected to be delayed or abandoned over the next three years. In addition, as commodity prices remain depressed, global mining companies have announces significant production cutbacks. Recent estimates reveal that 12% of global aluminium production has been curtailed, 11% of world nickel supply, 10% of the seaborne iron-ore trade, 6% of OPEC oil output, and 5% of global copper production have been cutback (which is very bullish when demand returns).

“It is important to note that the capex tap cannot just simply be turned back on. Considering the long lead time from the decision making process to the project completion, the investment in new projects and the commitment to production expansions is a very big ship which takes a long time to turnaround. Mining capex and business investment are long duration cycles, and as evidenced by the last major downturn in business investment in the Asian currency crisis, the mining capex cycle didn't recover for five years.

Aitken, in his latest market commentary, focuses on the mining service sector in the wake of earnings and revenue forecast downgrades by companies ranging from Caterpillar, Komatsu and Atlas Copco, to Macmahon Holdings and United Group.

He is possibly the first to note a link between US machinery giant Caterpillar's earnings guidance and inventory and “... activity levels for the Australian mining service sector, particularly the companies leveraged to base metals and bulk commodities which have significant earthmoving requirements”.

“Interestingly Caterpillar management confirmed that demand remained resilient from the gold companies,” Aitken said in an aside.

He noted: “In the current environment we would be very wary of expecting strong forward order books to translate to strong earnings growth for the domestic mining service companies and contractors. An order book is meaningless in the current environment.

“The key takeaway for the mining service companies is that profits are not just down significantly. More importantly, forward order books are being undermined as the global miners are cancelling brownfield expansions and greenfield projects. In this regard late last year both Rio Tinto (RIO) and Anglo American confirmed $US5b cutbacks each in cap-ex investment levels. In addition, history reveals that once commenced, this is a long duration cycle. As a result we believe there will be no V-shaped recovery for the mining service or contracting sectors.”

On the equity side of the sector “... even after 50% share price falls, the sector remains good selling”.