Major Drilling: The Turnaround Gains Traction

Summary

• Major Drilling is an industry leader with a unique business model, strong balance sheet, and good valuations.
• Recent results and outlook suggest the company could be turning the corner.
• Going forward look for further revenue growth, profitability, and higher utilization rates to determine if the turnaround is legitimate.

Introduction:

Major Drilling (OTCPK:MJDLF) is a drilling service company for the mining industry. It is listed on the Toronto Stock Exchange and is headquartered in Moncton, New Brunswick. Major Drilling is held within the Vice-President’s Portfolio here at Contra the Heard. The holding was last added to in December 2018 at $4.51 CAD, though the average cost is $5.51 CAD, meaning the position is currently underwater. However, although it is down versus the average purchase price, the shares appear cheap, and the company may finally be turning the corner after reporting losses for years.

Corporate Characteristics and Investment Rationale:

Major Drilling is a well-managed industry leader with a unique business model and corporate strategy. The company is globally diversified, has a modern and well-maintained fleet, and has deep relationships with both senior and junior miners. Their primary focus is specialized drilling, which management defines as “exploration or definition drilling, with significant barriers to entry, such as deep-hole drilling, directional drilling, and mobilizations to remote locations or high altitudes.” As they go on to note, the above specializations demand higher pricing and allow for wider margins.

In 2014, Major acquired Taurus Drilling to better endure the mining downturn and to expand its conventional and underground drilling services. These segments were indeed more popular than specialized drilling during the commodities selloff. While this shift to lower margin services hurt the income statement, it also grew Major into a turn-key service provider during a period of reduced specialized drilling. In the latest quarter, for example, 57% of revenues were generated from specialized drilling versus around 50% at the cycle low in late 2016, and down from roughly 75% in the period before Taurus was purchased.

The corporate strategy prioritizes employee safety, margins over volumes, and customer satisfaction via strong field and equipment support. It also empowers local operators when bidding on projects. By empowering field managers, the organization decentralizes decision making and accountability. In turn, this allows the field managers to utilize the expertise of local staff and incentivizes them to keep their people safe and do well by the customer. Major is often recognized for these efforts, as was exemplified this year by their winning the Prospectors & Developers Association of Canada ‘Safe Day Every Day Gold Award’ for the second year in a row. For those interested in learning more about Major and how it stacks up to its peers, Seeking Alpha contributor Simple Digressions has written extensively on the topic.

In addition to being an industry leader, Major has excellent financials, especially considering the depth and duration of the bear market. The balance sheet regularly sports a hefty net cash position, has ample working capital, and current assets often exceed total liabilities by more than two to one. Though the company has reported annual net losses since 2014 and eliminated its dividend in 2015, it still managed to continue generating positive cash flow, thanks in part to settling international sales in US Dollars, which reduces exchange rate risk. This ability to generate cash has allowed Major to uphold the integrity of their balance sheet, avoid dilution, and maintain the quality of their equipment.

During the last mining bull market, the shares traded over 2x price to sales and price to book. Since the bull market ended, the ratios have bounced between 1x to 2x. Today, Major is trading at the low end of this valuation range, presenting investors with a potential opportunity. Furthermore, as pointed out by Simple Digressions, the valuation gap between miners and mineral drilling companies is wide versus historic norms. Therefore, investors wishing to add mining exposure may want to consider drillers. Better yet, these low valuations are occurring at a time when the company’s prospects appear to be improving.

Recent Results and Outlook:

In December 2018, Major reported its first quarterly income since 2013. Revenues, gross margins, and rig utilization rates also reached their highest point in years after steadily increasing for many quarters leading into December’s press release. In February 2019, Major released its latest results and returned to a net loss. This was expected because the quarter is seasonally slow, as customers reduce drilling activity over the holidays and review priorities for the coming year. Management takes advantage of this lull in activity to refurbish and maintain its rigs. As a result, it’s often the weakest quarter of the year, with two months of revenue for three months of expense. In this case, add on a previously telegraphed $8.1 million one-time charge ($7.2 million of which was non-cash) related to the closure of operations in Burkina Faso, and the quarter met our expectations.

Source: Major Drilling’s December 2018 Presentation

Going forward, management expects increased demand from base and precious metal miners. Copper consumption is expected to exceed supply by a significant margin in the coming years, due in part to growth in electric vehicles. The average electric car will need roughly 180 lbs of copper versus approximately 50 lbs of copper in gas-powered vehicles; electric charging stations should increase copper usage too. Gold is in a similar position. Exploration spending has declined for years, and reserves at senior producers have fallen over 35% from their peak in 2011.

Competitive pricing pressures are expected to continue however, as some smaller operators forgo margins just to stay in business. Major has also faced tight labour conditions for several quarters. Many employees have left the industry since 2013, and the enterprise is having to pay up for skilled labourers and new staff training now that demand is picking up again.

Source: INK Research

Major’s executive team has been overly optimistic regarding metal supply issues in the past, but commodity prices are now improving, and insiders are putting their money where their mouth is. In the last 12 months the CEO has purchased over $92,000 in stock, and other insiders have been net buyers to the tune of nearly $328,000. INK Research can provide more details for those interested in Major’s recent insider activity or ownership.

Confirming the Turn – what to look for next and risks to consider:

Although it appears Major Drilling is turning the corner, the jury is still out. If the turnaround is real, the organization should return to profitability in the coming quarters. Revenues, gross margins, and cash flows should improve further. Rig utilization rates should increase too, and the tight labour market conditions should pass as ongoing training efforts start to pay off. If utilization rates don’t increase, or if labour is still a problem next year, then there may be bigger issues at play that could cause us to reconsider.

At Contra the Heard, we will be looking at insider trading via INK Research. If the turnaround has legs, we would expect executives and directors to buy more stock and hold the shares they already own. Other items to watch are the adoption rates for electric vehicles, commodity trends, and how the mining mega-mergers – such as the ongoing Barrick, Newmont, Goldcorp dance – impact reserves and exploration budgets. If electric vehicle adoption fizzles, M&A reduces exploratory work, or commodities fall, the recovery may prove to be ephemeral.

Conclusion:

Major Drilling is a well-run company with a strong balance sheet, management team, and business model. It is an industry leader and survived the multi-year mining downturn without sullying its balance sheet or compromising cash flows. The current valuations appear low and the turnaround may be gaining traction as implied by a return to profitability, growing revenues, and improving utilization rates. Proof of a legitimate turnaround will be continued profitability, more revenue growth, and better utilization. At Contra the Heard, the stock was last purchased in December 2018 at $4.51 CAD and our average purchase price is $5.51 CAD.

Investors interested in this firm should keep their eyes peeled for upcoming quarterly results or consider attending the Prospectors & Developers Association of Canada convention that is being held in Toronto from March 3-6, 2019. Major Drilling will be in attendance, their management team may be able to answer your further questions, and wandering the trade show floor may reveal other opportunities within the industry.

Disclaimer:

The opinions expressed – imperfect and often subject to change – are not intended nor should be taken as advice or guidance. Contra the Heard Investment Newsletter is not an investment advisor or financial advisor. The information enclosed in this article is deemed to be accurate and reliable, but is not guaranteed by the author.

All amounts are in CAD unless otherwise stated.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I am/we are long MJDLF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.