@Rick - you've got me thinking with this post regarding mining services companies being the sweet spot in today's challenging investing environment.

I have listened to a few commentators describe how the lack of investment in exploration and mine development will lead to a crunch at some point in the future. Probably nowhere more so than in Energy. In this podcast Dr Philipp Hofflin, the portfolio manager at Lazard asset management, explains how the under-investment in bringing new fossil fuel energy reserves on-line has been building up for some time. ESG mandates have been brought to bear, and further investment in new fossil fuel sources has been discouraged. The investment in green alternatives has been nowhere near enough to replace these fossil fuel energy sources. Events in Ukraine have thrown this issue into the bright sunlight and there has been a sudden change in priorities.

It is likely that there will be a significant increase in exploration and development of both old (fossil) energy sources and new ones (Li, Nickel, cobalt etc) in the next few years. The other huge question that gets thrown up is whether this is finally nuclear's time to shine.

Add in the geopolitical and sovereign risk and Australia becomes a very attractive place for all this new investment to go.

I currently hold MAD and RUL, and have been convinced by the investment case for DDH (thanks again @Rick) so will probably pick up some shares here too. I was initially concerned by the huge reduction in NPAT, but that appears to be a tax timing issue - please correct me if I am wrong.

GNP was my other big play on this theme - as well as green infrastructure - which currently isn't performing quite as I would like, but am confident will improve as the acquisitions get bedded down (see straw on the subject)

I do not hold any exposure to Uranium stocks. Maybe I should?

The risk with all of these companies that are exposed to boom and bust cycles is getting in and out at the right point in the cycle, and whether they can control costs ie the bottom line increases just as fast as the top line. The biggest driller (Boart Longyear) went bust in 2011.

The pressures on the bottom line appear to be mixed: energy and wage costs and inflation generally are increasing vs borders opening and COVID restrictions and days off work with illness are easing.

MND and WOR do not appear to be particularly cheap at the moment, but if this huge wage of expenditure arrives, maybe they are?

I'm sure @Bear77 will have some further insights, but would also appreciate others thoughts in general, and suggestions for overlooked companies in this space more specifically.

Best wishes

C

Talk about deja vu, I feel like I have seen this week on the market played out before…about 3 months ago. How quickly did the market forget about the looming higher interest rates until 8 days ago when Jerome Powell reminded investors with just a few words out of Jackson Holes, “Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy.” 

Then I start reading about ‘Zombie Companies’ in the AFR this morning, ‘Get ready for the first rates-led collapses since 1991’ Apparently over 13% of all ASX companies are zombies…the walking dead!

By definition a Zombie Company has “existed for more than 10 years and has an interest coverage ratio (ICR) of less than one for three years in a row. The ICR is defined as the ratio of a company’s earnings before interest and tax (EBIT) relative to the interest (note, not principal) repayments on the debt.”

As I read further into the story the news kept getting worse “Aussie housing crash is going to get worse - Sydney losses to exceed 10pc in months’.

More doom and gloom and the media is preparing investors for perhaps another week of losses.

Then I thought back to a story in the AFR that gelled with me about 3 months ago “Smashed Small Caps that can turn into portfolio treasures”

In this story Paul Biddle, portfolio manager for Celeste Funds Management said “The time to put money to work is when everyone is running for the fire exits.”

He also said “At times like these, few people want to own small-cap industrials. That’s when they get oversold”.

“In a weakening market, our preference is small caps that can reliably deliver a 4-6 per cent yield, before franking,” says Biddle. “That’s not a bad outcome if the sharemarket is flat this year. We liken an attractive yield to being ‘paid to play’ while we wait for market conditions to improve – and for our industrial small-cap portfolio stocks to re-rate higher.”

I thought that sounded like reasonable advice at the time, so I started reshaping my portfolio to include more highly profitable businesses with a track record of growth that paid out part of their earnings as dividends. There were some battered retail stocks in June that seemed to fit the bill that are now paying some handsome dividends.

So let’s assume things get worse from here, central banks struggle to get the inflation genie back in the bottle, interest rates continue to rise, households start to struggle and consumers stop spending.

In this scenario we certainly shouldn’t be holding any ‘Zombie Companies’ in our portfolio. Mortgage lenders could face higher risks if more businesses default. Discretionary retailers might start to struggle if householders have less money to spend. Commodity prices are coming off the boil as China’s economy slows, so miners profits could ease. So which industry is now profitable, has tailwinds, and can afford to ‘pay you to play’ the market?

The team at Intelligent Investor were discussing a few stocks (Resmed, Lovisa, Altium and BHP) on their podcast “Stock Take” on Thursday, and Gaurav Sodhi said, as he was thinking out loud - “This little golden period for mining might be coming to an end. It might be the time to switch to services businesses. Services companies have had a miserable time because of CapEX strikes, and with CapEx starting to pick up it might be time to look at services and drillers’’. Thats right…the guru and bull of mining stocks is thinking about mining services businesses!

This makes sense to me, and there are plenty of mining services businesses that have copped a hiding in recent years that are now reporting well, and are paying juicy fully franked dividends. Australia’s biggest driller, DDH1 Drilling, said in their FY22 report ‘strong industry fundamentals driving demand remain’ and ‘clients are well funded and have indicated their intention to execute drilling programs’.

Perhaps mining services companies could be the next sector in the market that ‘pays you to play’ while you wait for more stability to return to the economy and the markets?