Proactive Investor's  Instablog

Hughes Drilling (ASX: HDX) has been rated a BUY with a $0.06 value from Canaccord BGF, which is nearly 60% higher than the $0.038 last traded price.

The following is an extract from the Canaccord BGF report.

PROFITABILITY AT THE COAL FACE

We initiate coverage on Hughes Drilling Limited with a BUY recommendation. A strong focus on production drilling for the expanding coal industry, a growing fleet of drilling rigs, a focus on production drilling, and a strong EPS growth profile underpins our view.

The implied FY13 PER of 4.4x largely reflects the stock being undiscovered in our view and doesn't reflect the company's inherent value, which we see at $0.06 per share.

VALUATION AND RECOMMENDATION

We initiate with a BUY recommendation with HDX trading at a significant discount to our valuation and price target of $0.06 per share.

Our valuation is based on a target EV/EBITDA multiple of 4.5x, which is undemanding in our view given the EPS growth profile and relative earnings quality, afforded by its exposure to coal production and planned rig growth.

We see the short term drivers being (1) an improvement in sector sentiment; (2) new contract wins and (3) the establishment of a track record.

INVESTMENT HIGHLIGHTS

Hughes - an "undiscovered" story

Hughes was founded in 1991, and specialises in blast-hole drilling services. In May 2012, Hughes completed a merger with Every Day Mine Services (EDMS) and underwent a name change to Hughes Drilling Ltd ('HDX').

Operating 41 rigs for open pit coal mining operations in Queensland and NSW, HDX is the largest provider of blast-hole drilling services to the Australian coal industry. The merger has resulted in greater scale, an improved earnings profile and a stronger management team.

This improvement is not being reflected in the share price in our view, with the stock trading on a FY13 PER of 4.4x and an EV/EBITDA multiple of 2.5x. We put a large part of this down to the stock remaining under the radar.

Strong earnings growth profile

We are forecasting strong EPS growth in FY13 and FY14 of 33.9% and 25.9% respectively. FY13 growth is underpinned by a 12 month contribution from 5 new rigs added during FY12 and a further 5 due for delivery in 1H13.

We have also assumed a further 5 rigs are added in FY14. Management have flagged the acquisition of 13-15 new rigs in FY13 based on a strong tender pipeline so there is scope for upgrades.

Demand increasing in line with production growth

Investment being undertaken in the coal sector bodes well for blast hole services demand. According to ABARE, Australian coal exports are expected to increase by ~33% between 2010-2015.

This demand is to be fed by mine expansion and new coal projects. In Queensland alone, where there are 42 open cut coal mines, there are 27 advanced new coal projects and 8 mine expansions being undertaken.

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