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November 23, 2018

Macmahon Holdings

 

We visited the management of Macmahon Holdings (ASX:MAH) in Perth this week. It is one of GC1’s largest holdings and in the wake of some downgrades in the sector and chatter about union disruption, labour and equipment tightness we though it prudent to see how they are viewing current conditions.

 

In a nutshell the company has good momentum with no hindrances apart from the normal challenges.

 

Labour

In the current market we are already seeing labour pressures. The heavily increased demand by the East Coast infrastructure boom has absorbed many of the workers that were previously employed during the West Coast resources boom. Now that the resources industry is starting its renaissance, labour markets are beginning to be squeezed. We saw one company in the industry (MACA Ltd – ASX:MLD) downgrade recently, citing labour rate pressure on its contract margins.

 

It’s important that Macmahon has rise-and-fall conditions on all of its contracts. This means that when labour rates rise Macmahon can charge its customers for that inflation. It concurs that labour is tightening, but mostly in niche pockets such as heavy-duty fitters and welders.

 

Unions

In recent weeks we have seen some disruptions and costs suffered as a result of union pressure. Crane operator Boom Logistics (ASX:BOL) saw time lost due to industrial action and faces margin pressure from new pay rises awarded by the courts. With labour markets tightening there is the possibility that union leverage increases, as it did during the resources boom.

 

Macmahon has non-union deals on all of its contracts. It also uses a labour hire company – SES – which sources staff that Macmahon converts to salaried employees. It also works in remote locations which are more difficult for unions to organise workforces (not that it would be impossible, as it has been done before). This gives us confidence in Macmahon’s position.

 

Equipment

 

The MACA downgrade also cited equipment shortages and associated costs leading to margin pressure. We have crossed checked against miners and drillers in various jurisdictions and there is no doubt it is getting harder to get gear. Caterpillar in the US recently said it has a $17bn manufacturing backlog due to demand pressure.

 

Given Macmahon’s significant forward capex program on existing work and large $7bn pipeline of potential work this issue is an important one.

 

The company told us that it currently has all of its capital and financing in place for the current and planned workload. It has already begun planning for lead times out as far as January 2020 for work it has not yet won, for existing customers. It is comfortable with its ability to source gear 12 months forward; the OEMs are still pushing to do deals on that basis.

 

Hire fleet remains a viable option also.

 

Productivity

Macmahon suggests that downgrades in the current market probably have more to do with ferocious bidding on the first round of contracts in this cycle and perhaps misreading ramp-up costs in new jobs. The key measure ultimately is productivity.

 

Macmahon’s own problematic contract, Telfer, came about because the company misread the condition of the available equipment and the cost of mining the particular pits it was given. The company has now borne the cost of appropriate equipment and is mining the pits in the correct way. But this has taken time and came at a huge cost.

 

While there some fixed cost arrangement in its portfolio, most of Macmahon’s projects are now done in an alliance-style open book. This means changes are worked through with the client and the costs shared … so, for example, if it is wise to move to a higher grade but more difficult pit, the variation costs are determined and agreed upon before the solution is confirmed. This is a better way to ensure profitability for the contractor and a better outcome for the asset owner. Macmahon has done exactly that with its Tropicana project this year.

 

Management considers its current book of contracts is quite mature so that the operations are mostly in the execution and optimisation phase. It appears pretty comfortable and risks are relatively low.

 

Indonesia

This is an area which excites us. That is because of the profit share element of the contract. Macmahon’s 40% shareholder, AMNT, is the customer on the Batu Hijau mine in Indonesia, which gives us faith that the contract is low risk. Aside from normal rates associated with mining the gold pits, for every dollar Macmahon can save it gets to keep 40%, with AMNT getting the rest. This productivity can come from better deals in purchasing explosives, tyres etc (combining the buying power of both groups) plus improved techniques used around the mine like faster roster changes, less blast drill movement, improved maintenance etc.

 

On a $400m per annum workload, a 10% saving can mean a large boost to Macmahon’s bottom line.

 

Pipeline

$6bn of the current $7bn pipeline is with existing clients, including the extension of projects currently underway. This gives us confidence the group can take its forecast revenue from circa $1bn this year to $1.5bn by FY21. Macmahon is working to ensure it has the people, structure and technology in place to ensure this happens smoothly.

 

The potential in Indonesia, where AMNT is a huge player and has the right political connections and market respect, is strong. We expect the group to expand outside Batu Hijau within the next couple of years.

 

Conclusion

We believe the early scramble for contracts in the mining sector have caused some operators to price too low, or not factor in potential rising prices. Desperation does that to companies. The next round should see improving conditions as rising costs are passed through.

 

But it is largely irrelevant to Macmahon. It has a strong and maturing load of work and strong prospects of growing that. It has learnt from its past mistakes and has the management team to maximise the profitability of its workload. The stock is inexpensive (PER 7.6x FY20) with strong double-digit earnings growth over the next few years. Of course, contractors are vulnerable to sudden downswings in market conditions or execution error, but this one is in about as good a position as a contractor can be.

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Royal Exchange

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