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6 stocks to watch in 2017

Glenn Freeman  |  12 Jan 2017Text size  Decrease  Increase  |  

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These mining services companies are tipped for positive performance this year and beyond, but they won't outperform like they did in 2016.

 

Mining services is a catch-all term Morningstar uses to describe a collection of companies performing a vast array of different activities.

While some of the top-performing ASX 200 companies of 2016 were drawn from this sector, this seems unlikely for 2017. Mark Taylor, a Morningstar senior equities analyst, says he doesn't expect investment activity in the mining and energy sectors to bottom out until fiscal 2018.

"And even then, we expect only a modest turnaround--well below what the market is pricing in. Instead, we view growth stemming from increased maintenance activity, rising public infrastructure spending unrelated to mining and energy--particularly in Australian road and rail programs in line with government budgets--and other specialised non-mining activities," he says.

CIMIC (ASX: CIM) and Downer EDI (ASX: DOW) will likely see some benefit via their engineering and construction segments, as will Seven Group's (ASX: SVW) Caterpillar sales and servicing operation.

Orica (ASX: ORI) and Incitec Pivot (ASX: IPL) may also benefit through their explosives businesses, as they related to quarrying and construction.

ALS (ASX: ALQ), a global leader in testing, also makes the list due to its growing environmental, food and pharmaceutical testing business. Morningstar research shows Downer and ALS are the two fastest growers of these non-resource exposed businesses.

Infrastructure boom

Much of the resilience of some companies in this space will stem from their ability to transition away from mining- and energy-related activities into broader construction, maintenance and other related areas.

A Morningstar mining services sector report, released in December 2016, tips sharp growth in public spending on infrastructure, including roads, rail, hospitals, and defence.

While this is not likely to fully offset the slowdown in mining and energy, Taylor says: "We forecast 6.5 per cent per year growth in public infrastructure spending to fiscal 2021."

"We think the market is way too optimistic on the likely impact for infrastructure spending by the government to replace the large hole that was left by the end of the China-driven mining boom," Taylor says.

"It's not to say that it's not positive. We ourselves are forecasting quite optimistic growth in earnings and revenues, but we just think the market has got ahead of itself."

Private companies will complete a considerable proportion of works in these areas.

Data from the Australian Bureau of Statistics (ABS) shows a 20 per cent increase in private sector engineering and construction activity for the public sector in fiscal 2016.

Morningstar's report forecasts a low for Australian minerals expenditure this fiscal year, at $10 billion, 75 per cent down on the 2013 peak.

"We then project a rapid turnaround from fiscal 2018, from a position of underinvestment, driving 5.9 per cent five-year average growth to fiscal 2021," Taylor says. "We think this is required to maintain base-line production in the face of depletion and asset depreciation."

In the two years to fiscal 2016, Downer's transport, technical and communications, utilities and rail segments grew 35 per cent, from less than 30 per cent of earnings before interest, tax, depreciation and assets (EBITDA) to more than 40 per cent.

ALS grew its life sciences segment by 20 per cent, from 26 per cent to 33 per cent of EBITDA overall.

Proceed with caution

Despite the ongoing strength of these companies over the medium term, Taylor believes the overall sector is overvalued by around 35 per cent.

"We think the market unreasonably prices for double-digit five-year sector revenue growth, which would pitch levels above fiscal 2013 China-boom highs, by as soon as fiscal 2020," he says.

"We struggle to credit such a bullish scenario given the most commodities-intensive phase of China's development has already passed and government coffers are not limitless."

Taylor says that despite some difficulties around their capital allocation in recent history, these companies are "of sufficient calibre to justify investment if the price is right. We think a one third pullback on average is necessary for worthwhile opportunities to present".

"We don't see the decline in energy investment in Australia, for example, to hit a nadir until 2018 and that's because you've just got the tail end of this once-in-a-generation LNG construction boom still running its course.

"We're seeing mining expenditure bottoming a bit sooner in 2017. So, we're pretty much close to the low as far as mining spending goes, but a bit more pain in energy."

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Key takeaways from PIMCO's cyclical outlook

 

Glenn Freeman is Morningstar's senior editor.

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