In Australia, resources booms tend to come and go. In a recent speech, Reserve Bank Deputy Governor Ric Battellino identified five major booms over the last two hundred years — from the gold rush of the 1850s, to our current minerals and energy boom.
Many have argued that the current boom is different from anything we've experienced before, with the modernisation of the Chinese and Indian economies likely to keep demand high for decades. That's led some analysts to talk of a resources supercycle. And yet a supercycle is still a cycle.
Which raises the question: what's the best way for investors to tap into the potential of the mining boom, without the heart-stopping volatility that mining stocks sometimes deliver?
Legend has it that the people who really profited from Australia's gold rush weren’t the miners who flocked to the fields, but the store-owners who sold them their spades and pans. You can put the same principle to work today by investing in mining services and engineering companies.
Here are five reasons to consider giving mining services companies a place in your portfolio:
In November, the Australian Bureau of Agricultural and Resource Economics reported that mining and energy companies plan to invest a record $132.9bn in new projects, a 58% increase from the previous year. That includes 72 projects at an advanced stage of development, such as the $43bn Gorgon LNG project and the $20bn Olympic dam expansion. The mining services sector is poised to benefit from all of them.
The sector also stands to benefit from Australia's worsening skills shortage, with more companies looking to contractors to provide essential services in remote locations.
Resource stocks tend to fluctuate with commodity prices, which are subject to international economic forces and market sentiment beyond the control of any individual company. As a result, they are among the most volatile companies on the Australian sharemarket. But mining services stocks, while still exposed to the commodities cycle, tend to be more stable.
One reason for the comparative volatility of commodity companies is that their cash flow can be very variable. In the development phase, they need to make significant capital expenditure, often leading to negative cash flows. And while they enjoy healthy revenues in the production phase, that revenue may diminish as a resource is exhausted, unless they make further investments in exploration and development.
In contrast, mining services companies require comparatively little capital investment, with more predictable cash flows over the long-term.
Predictable cash flows and lower capital expenditures often allow services companies to pay out more of their earnings as dividends, making them more appealing for income-oriented investors.
Many miners are highly leveraged to demand for a single commodity, whether it's gold, coal, copper or iron ore. Some are reliant on a single mine or field. Whereas services companies generally have a more diversified customer base.
The table below shows key ratios for a variety of mining and energy services stocks, with BHP and Rio as benchmarks. While I am not recommending you invest in any of these stocks, these figures do reveal a few interesting things:
So, if you're interested in getting exposure to the mining super cycle, it could be worth looking beyond the mining sector at companies like those outlined above, including drilling, freight rail, construction, engineering, project management and other contracting services. You might just find an investment 'goldmine'.
Happy investing!
Happy trading!
Julia Lee Equities Analyst Bell Direct Have you started trading with Bell Direct for just $15 a trade? Register now for free.