Mitchell Services Limited (MSV) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Mitchell Services Limited Half Year Results Presentation. [Operator Instructions] Please be advised that today's conference is being recorded. I will now turn the conference over to your first speaker today, Mr. Andrew Elf, Chief Executive Officer for Mitchell Services Limited. Thank you. Please go ahead.

Yes. Thanks very much for the introduction, and welcome, everybody. Thanks for your interest and attending the call this afternoon. With me, I've got Greg Switala, who is our Chief Financial Officer and Company Secretary; and also with us is Nathan Mitchell, our Executive Chairman. Greg and I will run through the presentation today, and then we'll open it up for questions at the end. And when you ask your question, just kindly ask if he would like to address that, too, obviously as well. So we'll get started. We'll take the disclaimer on Page 2 as being read. Let's move to Page 3. Obviously, there, with the usual points we make here are the major shareholders and the founder connection, with Nathan being a major holder and Scott Tumbridge, who was the founder of Deepcore as well and a pretty good [indiscernible] for a company of our size. On Page 4, people, risk and sustainability. Certainly, there's been a lot of press out there regarding critical risks and some of the events that have occurred in Queensland in the mining sector from the Brady report and others, and that's certainly been a big focus of ours sort of over the last year and in the last 6 months in particular. And we do now have a critical risk management program that's in use in the field, and our performance in that regard has been exceptional. COVID-19 continues to present challenges, and they sort of come and go depending on what's opening and closing. But all in all, I think our teams have done a wonderful job and have continued to deliver a safe and efficient service to our clients. We've developed and released our modern slavery statement, which has now been published, and that was a big effort from the team as well. And lastly, that Mitchell Services Foundation has been registered. The overview of the business for the first half on Page 5, just running along the top there. So revenue up year-on-year and EBITDA up, noticing that it's the underlying EBITDA. Net debt down. Again, that's been a focus of the team in recent times and great to see that we're in a strong position from a balance sheet perspective in regards to net debt. We've given our guidance, which we have done at the same time in the last couple of years, and it's sort of staying there $190 million to $200 million on revenue; underlying EBITDA, $38 million to $42 million; and I think Morgans had us penciled in their guidance about $38 million. And obviously, the statutory EBITDA guidance, $29 million to $33 million. And again, we'll talk about it as we go through the presentation that continued improvement in key operating metrics across the business as the strength of the market continues to improve as well. So on 6, operational highlights. Obviously, strong underlying performance. We've obviously had that impairment loss on the trade receivables, and I'm sure we'll talk to that in the presentation. We may even get a couple of questions. But again, a very disappointing event. But needless to say, that is our first impairment from a receivable perspective. And notwithstanding, I think the business is in excellent shape and that it really is a good business, a great team in a strengthening market, and there's still a lot to look forward to moving forward into the future. Rig utilization, again, impacted by COVID-19, but it's certainly moving back in the right direction again now. The diversity by commodity, geography and type, there's a slide I'm not going to get to, but it's just continuing to improve across the board as well. 80% of the revenue from Tier 1s. And again, that's slightly down where it has been and probably representative of the fact that there is more money being raised in the junior space, in the Tier 2s, and we're taking some of those opportunities as they arise for us. Slide 7 shows the impact of utilization on the business, and you can see there the change over time. Obviously, the right-hand bar there, the average rig count operating throughout the first half of 2021. And the lines on the top half of that bar, obviously, the guidance; and the gray part, at the very top, the dark gray, is that guidance range, so obviously, $190 million to $200 million. Obviously, these things can change, obviously, up and down due to seasonality of factors. But we're anticipating that, that rig count will continue to increase as we move forward throughout this calendar year. Average operating revenue per rig, again, it does move around based on certain things. But again, I think it's still heading in the right direction. The revenue diversity on Slide 8. Again, something that we say sets us apart from our competitors, given that the broad diversity that we do have. The surface and underground mix fairly much the same. Commodity, I think that commodity mix is the best shape it's been for us as a business now. We've got 0 exposure to thermal coal, and we do not intend to work in that space. 30% of the business is met coal, and that's obviously bounced back from about $100 a tonne to $160 pretty quickly in recent times. Base metals, obviously, represents 70% of the group's revenues now, and we're in a very strong position to capture further upside in that space as it continues to improve, particularly with government stimulus packages and other things, and I'll talk about that further on in the presentation as well. The Victorian revenue and underground increase, obviously, are driven by the acquisition of Deepcore back in November 2019, and that business is performing well and certainly meeting expectations. Great team, great culture, and we're very well positioned in Victoria to take advantage of further growth in that market as well. Slide 9. As I briefly mentioned before, you can see the movement in the Tier 1s. Obviously, from a contract book perspective, all the remaining contracts that we do have in our business are with listed clients. There are no other private company contracts in the contract book. That's not to say that things can't happen with listed companies, they can. But again, consider the quality of the contract book there and where we work on that mining life cycle stage. And we also make the point that we think that percentage will remain fairly constant as we move through the second half of the year. So just on SMS. We thought it's good to put an update in here for everybody. I've obviously made the point on the last slide that the balance of the contracts that we have of the listed companies. We obviously went into this contract in good faith, knowing that it was a large proprietary company with genuine earnings. Again, we make the point here, Nathan had a shareholding that -- in a company that owned the Kirkalocka Gold project of approximately 18%. Obviously, it's on that Kirkalocka website and previously announced 33%, but it's 18%. And again, Nathan has 0 shareholding in SMS and no liabilities to SMS. Obviously, from an accounting perspective, we make the point there that was considered an impairment under the accounting standard, and we acted accordingly. And again, Greg may talk to that a little bit more in his presentation. We will absolutely do everything we possibly can to vigorously pursue that debt that we believe is outstanding and due to us. And again, as we mentioned in announcement in conjunction with the presentation today, an application has been received to set aside the statutory demand in the Melbourne Supreme Court, and that's on the 10th of March 2021.

Looking at the profit and loss on 11 and noting that numbers are underlying. Both revenue and EBITDA increased by approximately 40% as a result of improvements in key operating metrics, in addition to the Deepcore acquisition that completed in late calendar year 2019, while EBIT and NPAT grew by 11% and 5%, respectively. Underlying EBITDA margins remained strong at circa 20%. And as Andrew said earlier, we expect underlying FY '21 full year EBITDA to be between $38 million and $42 million, which would represent an increase of approximately 25% versus FY '20. Slide 12, looking at the balance sheet. Whilst the $7.3 million impairment of trade receivables has seen a reduction in the group's current ratio, MSV remains well funded to take advantage of the various growth opportunities that Andrew referred to earlier in an improving and strong market with access to a $15 million revolving equipment finance facility and strong liquidity coverage. From a cash flow perspective on Slide 13, it is worth noting that the group has utilized all of its previously available carried forward tax losses, and as such, was income tax paying in 1H '21. Despite this fact and the $7.3 million trade receivable impairment, cash flows from operating activities grew by approximately 12% from $14 million to $15.8 million, with these cash flows primarily used to fund capital expenditure, whilst at the same time, reducing overall debt levels. Net debt at December 31, per Slide 14, has decreased by approximately 15% since June and 39% since December 2019. The group's drawn debt at half year comprised $20 million in equipment finance and a $12 million corporate market line. The ratio of the group's net debt to 12-month rolling EBITDA is currently approximately 0.7x and has continued to decrease over the past 12 months. Looking at first half CapEx on 15. We generally forecast maintenance CapEx to trend in line with P&L depreciation multiplied by current utilization levels. Maintenance CapEx as a percentage of depreciation was 44% in 1H '21, at current utilization levels of well in excess of 70%, implying that second half CapEx will increase versus first. Growth CapEx in the first half includes the commissioning of a next-generation large diameter rig as part of a broader upgrade and innovation program, and the group will also look to accelerate this program to take advantage of the government's Instant Asset Write-Off Scheme that is in place until June 2022.

So just on to Slide 16 and talking about the industry overview. And again, if anyone wants to ask any questions at the end of the presentation, I certainly think Nathan is a good person to talk to about where the industry is at. There's a few key points we're making here, significant increase in demand in gold and base metals with a positive outlook. I think as we make the point at the bottom there, the market conditions are the strongest that we've seen for quite some time, supported by a lot of commentary in the media in recent times, including the little quote that we've got in there in the presentation certainly. But government stimulus and subsequent [ investment ] into infrastructure and other projects, copper, base metals is going to be very strong moving forward. Australia is a very strong jurisdiction. When we were last at PDAC probably a year ago now or so, the feedback from all the majors was Australia is a very attractive place to do business and to explore and to spend money, but I think even more so now with the way that we've managed COVID. We're certainly seeing a lot of money that was raised last year starting to go into the ground and programs increasing. And I think it's fair to say that the opportunities and the size of the pipeline far outweighs the rigs available to us, and we really have a positive pathway ahead for the business. So I certainly think that we're very well positioned, as we say, to take advantage of the market as it continues to improve moving forward. So the outlook, that top point there, I've sort of touched on that, but again, pipeline is very strong across the board from Tier 1s as well. And the rigs available to us are going to exceed -- the opportunities are going to exceed the rigs available to us. Gold is strong, but again, we're seeing everything else strengthen now as well, including copper and other base metals. We've talked about our guidance, that it's $190 million to $200 million, and underlying EBITDA, $38 million to $42 million, respectively. And again, we're considering current utilization levels from existing contracts to make those -- that guided -- those guided numbers. And as we said earlier in the presentation, those numbers can go up and down obviously, but we're in a fairly strong market. And again, we are covered by Morgans. So I'll certainly point people in that direction if you're interested in having a look for what coverage is out there. From a capital management perspective, obviously, impairment has had an impact and certainly created a little bit of uncertainty in that regard. And again, the final decision on dividends and buybacks in the short term probably need to get a little bit more clarity and visibility on things before decisions are made in that regard. From a debt perspective, again, I think the team has done a wonderful job of getting that down to where it is, and it will continue to be a focus. But as Greg alluded to, we will take advantage of a strong market and certainly look to take advantage of a government assistance program as well. And again, we make the point down the bottom that members of the Board and management intend to purchase shares in Mitchell in the short term. So in summary, our vision is to be Australia's leading provider of drilling services. And again, we are a very diversified drilling company, and I think we're in a fantastic position to take advantage of the market as we move forward. We've got a very high-quality client base, and again, they're spending a lot of money and growing as well. We've got underlying EBITDA guidance out there at $38 million to $42 million. And again, importantly, in a services business, a strong balance sheet to give you flexibility to take advantage when opportunities do arise. So that concludes the formal presentation. I'll just hand back to the moderator to -- and [ everyone ] on the call, welcome any questions.

[Operator Instructions] Your first question comes from the line of Tom Sartor from Morgans.

I guess the question is probably for all of you. But with Nathan there, I guess, the thing investors want to hear about is that receivables position and how it got to that scenario and what changes you might be thinking about making next. And appreciate the matter's heading to court so that you might be limited on what you can say, but any color around any changes that might have helped to crystallize in the business?

Thanks, Tom. Nathan here. Yes, unfortunate. Definitely, I think the business, as it has for every year, the past 4 or 5 years has been significantly [ growing ] in the right direction. Obviously, this is not what we wanted. We went into this because we believed Western Australia was a growth sector. We entered a long-term 5-year contract. It was mine facing. It was -- so it was exactly around the strategy that we wanted. Unfortunately, it hasn't panned out as impressive as we liked. But overall, I think the reason why we got into it was right numbers that has done it and [ I believe ] negotiations and transactions right at the start. So sure, I think what will we do in the future, obviously, we talk about Tier 1 and we talk about listed companies versus private companies, that's certainly something to look at going in the future. I think, overall, the business is -- the full of the team and the business -- and the underlying business is excellent. I don't think that the current valuations represent the business as a whole. I think there's significant upside in the business going forward. Obviously, the matter is now between -- before the court. So we don't, obviously, want to say too much around that. But suffice to say that the contract is between MSV, Mitchell's and SMS. And I am a minority shareholder of the headco. And so obviously, there's discussions there. But overall, I think it's a hiccup that we have to deal with. It's a big one, it's not a small one. But we will obviously vigorously go after what's owed to us. I think this is the next on job in its operations. And I think the following next 6 months on this will be good for the company.

All right. Just as a follow-on. You've mentioned capital management in your last few releases. And obviously, you've got a clear view on value and the share price here and buying on market, that sort of thing. Does what happened change your comfort range of net debt held in the business, either in absolute terms or on a metric? And what is that comfort range going forward? I take it that you're comfortable holding some debt while also embarking on capital management, perhaps next time around.

Happy to take that one, Tom. I suppose the first question, has this event changed what we deem an adequate comfort level, I don't think so on the basis that this is genuinely, as Andrew said earlier in the presentation as well, the first case of an impairment to trade debtors or a provision for doubtful debts, whatever you want to call it, and we genuinely see it as a once-off. So on that basis, I don't think our long-term debt to EBITDA comfort or forecast range changes. And we've always said appreciating the fact that it is a cyclical business, we would sort of want to look at sort of a 1:1 debt-to-EBITDA ratio on sort of a stress-tested EBITDA basis. And I suppose what I mean by that is in the troughs of a cycle, what could the potential EBITDA look like. I think a ratio or a debt ratio of 1:1 on that basis is probably where we feel comfortable and appropriate.

Terrific. And just to clarify, what's happening with the rigs that have rolled off that site in WA? I think you alluded to potentially disposing them. Or are you looking to redeploy and then continue that sort of growth strategy into that market?

Thanks, Tom. Do you want to...

Look, I think that the Drill and Blast rig at the moment are a hot property. There's a lack of supply at the moment. So I think from our point of view, if we can -- where people have approached us about buying them. So I think we're open to discussions at the moment about who -- what we do with them. But at the moment, WA is exceptionally busy. So we'll probably end up selling them at this stage.

And your next question today comes from the line of Nick Robison from Jarden.

So just a couple of questions from me. First, I wanted to get you to draw out a bit of color on your outlook. Not, I guess, asking you to hold yourself to anything, but you comment that in your current contracts, strong opportunity pipeline exceed available rigs. Can you give us some color on what that means, and where things could be in 12 or 18 months? I mean is it fair to interpret that if you were -- if you -- when -- what you're seeing coming down the pipeline, then we could see you with the full 99 rigs out in the field in 12 or 18 months' time all going well. I can see you've ordered another 4 rigs as well. So it seems that you are buying ahead of what you see as demand. So I'm just trying to understand what it is you're actually sort of pointing to here, given you've got 75 rigs out now and 99 in the fleet, that would imply potentially a very big uplift in activity.

Yes. Thanks for the question, Nick. It's Andrew here. I think, again, the best way to look at that and the way we look at that is we effectively go, okay, what is the pipeline. It's made up of different types of drilling, surface, underground, in different locations. And you'll effectively add them all up and go, well, how many rigs do you need for those opportunities, when are those opportunities going to be operating and how many rigs have we got? And you go, okay, you assume that our current conversion rate is x, and I say a 30% conversion rate or 1 in 3, that would equate at the pipelines, 50 rigs. You're doing 1/3 of that. You'd work out how many rigs you're going to need and overlay it against what you've got. And you've either got not enough or enough. And I think looking at that pipeline, with certain types of rigs that we've got, it certainly exceeds the rigs that we do have available. So I'd never say that we're going to have 99 out of 99 rigs running. I think we're always going to have a number of rigs that are stopping, starting, finishing, moving, getting rebuilt, et cetera. So I think I've always sort of worked on 90% is a good number to say, hey, that's pretty heavily booked out. But I just think that, with that money that's continuing to get raised and the positive things we're seeing from people like IMDEX Index making announcements about the number of tools and ALS with their labs and other evidence that we're seeing and the calls we're getting and the tenders that are coming, it just points in the right direction with everything we're seeing.

Okay. Yes, I mean I saw Kirkland increased its exploration budget by nearly 50% year-on-year this morning. So I mean it's indicative of, I guess, how much things are potentially picking up. I mean -- so secondly, I can see that you've ordered -- or there's a forward CapEx commitment for another 4 rigs that will come in, obviously, I would guess, in the second half. Maybe this one, I'm not sure if it's for Andrew or Greg. But you're obviously taking advantage of the tax incentive here and in light of the decision to delay any decision around dividends or buyback, I mean, how many rigs are you potentially looking at buying here in the second half? Because it seems you're prioritizing that rig growth or reinvesting in the fleet over and above the dividends and buyback at this stage.

Yes. Thanks, Nick. It's -- again, it just depends on what comes. I think where a lot of drilling companies have gone wrong in the past is they've loaded up on rigs and orders on spec. And I think it's something that we've been very prudent with over time is that we buy rigs when we've got opportunities available to us. And I think from my perspective, it's something that I think is the best way to run a drilling business is to -- yes, you might buy a couple of rigs here and there like that. But all in all, you really want to try and be buying rigs for opportunities that you think you're going to convert or win and have in hand. So I don't think we're going to be making big, long, large commitments like that, but it just depends on what we see the market moving forward. Again, the decision just changes based on what can happen in the market.

Okay. And then one last one for me. Just around, obviously, what's happened with SMS. And obviously, rather unfortunate being a contract that these things do happen occasionally. But just wanting to understand your systems. One thing that's maybe a little bit surprising to many of us is that it looks like it's gone about 6 months before you got to the stage of cutting them off. So just -- maybe this is for Greg. But I mean just trying to understand how you look at the receivables and when you actually understand at the end of period, you've got to do this forward recovery test. But I mean, on a month-to-month basis, can we have confidence that if something is looking like it could be an issue going forward, that you wouldn't let it run 6 months again before stepping in to try and improve recoveries?

Yes. I think, look, from our perspective, contracts are generally, if we exclude SMS for effect, generally between ourselves and Tier 1 global [ suppliers ] with little or no risk of -- or credit risk. And then with regards to the other 20%, be it either juniors or, in this case, large privates, a lot of the information for the -- in relation to the juniors is publicly accessible on -- via the ASX, and you can clearly see what funds have been raised for what drilling programs. So you always have pretty good visibility in terms of what cash balances look like. In a case of a large private like SMS, the DD was already done, being large and with accessible accounts on ASIC. At the time, a $60 million EBITDA company and so the necessary steps were done from an initial assessment. In terms of your question with going forward, to be honest, it seldom gets aged, just given the counterparties that we generally work with. But we've got to -- at the same time, we've got to acknowledge that the -- work with our customers to a certain extent. And without giving too much away, given that there is a pending legal claim here as well, also need to be mindful of the fact that under the general contract arrangements that we have, we can't simply stop and walk away. There's a process where -- there's a process that you've got to undertake, both in terms of initial breach notices and notices with regards to ultimate termination. And that generally takes time as well. And I suppose outside of that, I'd probably prefer not to comment on this one in particular, given, as we said earlier, the claim that is out there.

I do think also that contract significantly expanded over the original $33 million. So what was potentially 5 months is actually less than because it's obviously more income per month. It was a $33 million contract, it would probably end up being significantly higher than that if it had run its full course. So obviously, whilst it's positive in terms of revenue and earnings, it also has the effect of increasing the receivables exposure.

And your next question today comes from the line of Richard Fakhry from Phoenix Portfolios.

I'm just trying to understand the SMS receivable issue a little bit further. I might be looking at outdated information on the internet, so I do apologize if I am. I'm trying to understand, is the big part of Adaman Resources?

I'm sorry, this is not a very good line. I couldn't hear the question clearly, I'm sorry.

I was trying to understand the SMS receivable issue a little bit better. Is the head company you're referring to Adaman Resources?

No.

It's not?

The client, in this case, is SMS.

Right. But the underlying, I guess the owner of the project?

The owner of the project is Adaman Gold.

Okay. Right. And so just to be clear, and I apologize if this is outdated, but are you the chairman of that company, Nathan?

No, I'm not. I'm not on that Board.

Right. So [ could you distinguish for me ] Adaman Gold from Adaman Resources somehow?

Yes. Adaman Resources owns Adaman Gold.

Right. And then Daniel Sweeney, who's the founding director of SMS, is also on the Adaman Resources Board?

That's correct.

And so I guess the logical question is kind of what is kind of any role did you have in the appointment of SMS?

A role that I have?

Yes. Well, as the chairman of the ultimate head co.

I'm not the Chairman. I wasn't the Chairman at the time.

Of Adaman Resources?

No, I'm not the chairman. I'm not on that Board either anymore.