ASX-listed ALS has been further punished by the market for not having immediate answers. The company has dropped more than a third of its value since the start of July this year and is now capitalised at about $2.2 billion.
ALS derives just under half its $1.5 billion annual revenues from minerals and coal, and said last week pricing pressure and reduced market activity would see revenue for its minerals division down about 25% for the first half of the current year compared to the same period in 2013.
This was in line with global exploration trends which had exploration expenditure – excluding coal and iron ore – down 34% in the June half year compared to a year earlier.
“It remains difficult to predict trends in the demand for ALS’ services and pricing pressure is being experienced by all our business divisions,” ALS said.
But the company now expects underlying net profit after tax for its half-year to the end of September 2014 to be $64 million, 36% below the $100.7 million achieved in the previous corresponding period. Revenues for the half are put at $755 million, compared with $745 million last year. Public interim results are due near the end of November.
Morgan Stanley said while the consensus market view of ALS was “overwhelmingly bearish” recovery in the mineral exploration sector in calendar 2015 could “challenge this mindset”. Mind you, there would seem to be caveats galore to the MS reading.
Signs exploration activity would bottom in the next three to six months were key to any resetting of the ALS valuation, with the stock offering strong cyclical exposure to mining and exploration levels, offset by exposure to defensive industries, the bank said.
“Tracking global minerals exploration trends in any sort of timely manner is challenging with most available data sets significantly outdated by the time they are published,” Morgan Stanley said.
“The one exception is Australia, where a significant amount of exploration data is available, one quarter lagged. Although regional differences exist, drilling incentives are largely consistent across geographies and through a cycle we expect the trends witnessed in Australia can be translated to other markets.”
A comparison of Australian non-ferrous exploration versus global activity underlined the truth in this, the bank said. Charting of Australian nonferrous exploration expenditure and worldwide nonferrous exploration budgets over 25 years showed the correlation in spending trends.
“Despite a concerted move to diversify operations, business [of ALS] remains leveraged to the global minerals exploration cycle, primarily through its role as the world’s largest assay tester,” Morgan Stanley said. “Recoveries in exploration have historically led to outperformance in [the company’s] shares.”
The bank’s analysis indicated overall exploration activity levels, based on metres drilled, were near all-time lows (at least for the period going back to 1989), despite most drilling now being production-oriented. Exploration expenditure levels for gold and copper (accounting for an estimated 70% of ALS’s exposure) similarly were in real terms very close to the lowest levels in 27 years.
But real gold and copper prices were elevated relative to prior troughs, arguably incentivising drilling. Meanwhile, drillers continued to cut prices, suggesting metres drilled would recover even if expenditure was flat.
“Clearly Australian exploration activity is weak and continues to trend negatively. However, we believe the underlying downturn for non-ferrous exploration has actually been worse than implied by the headline data,” Morgan Stanley said. “In other words, we may be closer to the bottom for testers and ALS than the headline exploration data suggests.”
Morgan Stanley said high iron ore exploration spending in the past decade had come to distort the Australian picture, with continuing falls likely in the sector, which probably meant more negative exploration expenditure headlines. ALS, though, had very little exposure to iron ore exploration and testing.
However, market sentiment would continue to play a part in the company’s fortunes.
“Our analysis suggests we are close to the bottom for exploration activity in [ALS’] core commodity set – gold and base metals,” Morgan Stanley said. “Although this would be a significant milestone in itself we believe scope exists for the non-ferrous exploration cycle to move beyond a floor in FY15 to stage a modest recovery in FY16.
“ALS should lead any exploration recovery as its assay volumes are directly tied to metres drilled not the dollars spent on exploration. History shows that metres drilled lead turning points in exploration as drilling prices tend to lag the initial phase of a recovery, and downturn.
“As we expect drillers will continue to soften prices – even in the early phases of the recovery – [ALS] could surprise investors by showing a return to volume growth earlier than would be expected should analysis be limited to a simple perusal of exploration budgets. As a result, we expect ALQ should see some recovery in its assay volumes even in a scenario where exploration expenditure stays flat in CY15.”
Other possible headwinds? Morgan Stanley’s commodities team is forecasting a sustained decline in gold prices through to 2017.
“Higher gold prices tend to act as an incentive to undertake greenfield exploration, however, with greenfield exploration expenditure already extremely low, mathematically it can’t fall much further.
“[But] the low point of gold exploration expenditure in 2014 already looks likely to exceed that of prior troughs, limiting further downside risk.”