Delta SBD – A recent float with promise and a macro tailwind (DSB)

This is what an underground longwall operation looks like

Whenever I run a value filter it will spit out 50-70 stocks on the ASX which meet my criteria, and most of them are either garbage (easy to bin) or marginal (much more difficult to separate and easy to make a mistake with that costs you lots – VMG looked good at 35c in January despite a quite high debt load, until the belly fell out of their project pipeline and they nearly breached banking covenants.  The share price closed on Friday at 4.5c)

After exhaustive analysis one hopes to find a few companies who have the right metrics in growing industries, with sound management and no major problems.  One example in 2011 is SNL, whose share price has risen 75% along with 5c in dividends.

Delta SBD is a mining services business which specialises in outsourced underground coal mining relocation projects and ongoing operations.  DSB has 3 big things going for it: It’s priced well, It’s generating solid cash, and it has a healthy macro tailwind.  The CEO also owns 1/3 of the company.

This blog is supposed to be about value investing, so I’ll begin with value.

DSB floated at $1.00 in December last year and since then has bounced off a low of 55c to the 70c-75c range.  Based on Friday’s close of 68.5c, the company’s numbers look like this:

Market Cap: $30m

P/E: 6.2

P/Book: 0.62

Debt/Equity: 13%

Giving us a business with moderate debt selling for less than 7 times earnings and 2/3rds book.  So if the underlying business is sound, this stock looks like it has a reasonable margin of safety.  The $8.85m operating cashflow and $3.59m net cashflow is also a nice figure for a company supposedly worth only $30m.

 

As of 30 June 2011, Delta SBD has $9.9M cash, and $6.2m Debt.  In FY11 they earned $4.75m on revenues of $83m and EBITDA of $9.4M.  Cashflow was $3.6m.

The forward looking order book is also positive, with FY12 orders of $98m, FY13 orders of $93m, and FY14 orders of $69m.  With another $348m in the pipeline, you can see why Delta’s committed to another $15m worth of new equipment.

Delta SBD generally works as a Subcontractor to other mine operators working on behalf of end customers like Anglo Coal and Xstrata.  Importantly, the only full outsource job is for Boral: most of the projects Delta engages in are things like secondary support and longwall moves.

Turning to the macro level, despite rumblings in China and India, I am very bullish about both Thermal and Coking Coal this century.  The massive investment currently underway (in Queensland particularly) in new export capacity means that additional mines will be coming online to take advantage of this capacity.   And new projects means more work for Delta.

A new market to soon open up is the Surat Basin (reliant on the Southern Missing Link and 3 separate coal export terminals currently under development around Gladstone) which mainly consists of underground longwall projects, a niche in which Delta has plenty of references.

 

Despite all the good news, it’s important to review the vulnerabilities, and so far I’ve counted three:

Contract expiry: Delta doesn’t have long-term contracts, and all current contracts appear to expire in 2013.  The mine lives are generally 20 years+ and the forward order book is strong, so this is not a great concern.  What would set off alarm bells would be contracts for ongoing work not being re-signed, which would indicate business lost to competitors.

Human Resource: Probably the biggest challenge I see Delta facing is recruiting skilled operators.  Delta aren’t sitting on their hands though, and there is a level of skills transfer between projects.  With things like employee share plans and traineeship alliances in place to drive recruitment and retention, Delta can hopefully keep the right people on board to continue their success.

Plant and Equipment: With plenty of equipment to service new and existing contracts, Delta has some level of vulnerability to equipment obsolescence and redundancy when existing contracts expire.  Delta may also encounter difficulties obtaining the necessary equipment to fulfil future contracts if demand for certain equipment exceeds supply.

 

DSB’s main competition is Mastermyne, another mining services company which while it isn’t selling for the same bargain price, does appear to be a reasonable business based on an initial inspection.  While I’m not currently comfortable buying into DSB I intend to continue researching this industry to increase my knowledge and hopefully avoid a potential “gotcha”.  I’m perfectly fine with a missed opportunity, rather than getting into a hastily-researched mess which results in losses. My background in telecommunications doesn’t translate well into the contract services business, so it’s important that I recognise my limitations.

2 thoughts on “Delta SBD – A recent float with promise and a macro tailwind (DSB)

  1. Nice post Leon. DSB wasn’t one on my radar but it is now. Definitely interesting at current prices.

    Funnily enough VMG might be worth a look as well. Flush with cash after the cap raising and Cape sale (something like 4cps), winning contracts and scheduled to return to profitability sometime this financial year. Though it does have tons of options on issue which will lead to quite a bit of dilution when/if they are exercised. Disclosure: I don’t own any, but monitoring the situation.

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