Description

Long MacMahon holdings

All values are given in AUD unless otherwise stated.

Never thought I would do a second writeup of this stock after 7-8 years and a pretty disappointing performance (just up 45% including dividends over an 8 year timeframe, nothing to get excited about, although it did almost triple over the years to here from the price of my original writeup).

Then again, MAH’s shareprice is still at the same level as the depths of march 2020 despite the strengthening in some of their end markets. And it’s trading at less than 2 times EV/EBITDA, less than 5 times earnings (less than 6 times if you normalize the tax benefits) and about 2/3’rds of book value (which is almost absent of intangibles).

Given the recently higher metal prices, which usually lead to higher contract miner margins, it is a reasonable assumption that profits are likely to increase in the near future from a macro perspective. But besides these macro factors, there are more company specific reasons why I think MAH’s earnings are expected to rise in the next 2-3 years, even substantially.

MacMahon holdings is an ASX listed contract miner. Contract miners are not a great business but a well managed company can achieve a 10-15% ROE over the commodity cycle. Another disadvantage about contract miners is the need for large capex programs in big yellow equipment to grow the work on hand, for usually pretty low ROE’s and margins. And we shouldn’t forget the need for additional working capital when they enter new contracts.
A last big disadvantage is the ease with which miners can annul these contracts and often even take advantage of contract miners in bad times by taking over the yellow equipment at depressed prices.

Despite these drawbacks, I still believe MAH can be a compelling investment, and not solely due to it's low valuation.

Recent History

After the 2012-2015 mining downturn, MacMahon found itself in between a rock and a hard place. It lost almost all of its contracts (from large companies like Fortescue, Rio Tino and Newcrest) with about just the large Tropicana gold mine (and it's 20 million yearly EBIT contribution) remaining at the end of 2015 and some smaller short term works.

In this situation, MacMahon tendered on some contracts which it better didn’t and got a life of mine contract for the exhausting giant Telfer mine in Australia. This contract dragged down their results in 2016-2017 and they were even losing quite some money, to the tune of more than 1 million a month and even 27 million in its first year according to some. In 2019 there has been a renegotiation of this contract so it became cash positive. So needless to say, a really bad contract but it is included in the current results.

One more of these “risky” contracts is the Mount Morgan contract for Dacian Gold. This is a higher cost gold mine for a somewhat stressed miner (they recently did a capital raise, even in a pretty decent gold price environment). But as of now, I think this is a pretty profitable contract for MAH but with a certain risk going forward. While there are no problems yet with this contract, I think there is a reasonable possibility that this mine will cease production in a lower gold price environment.

In 2017, with little contracts in their possession, MacMahon did an exchange offer with Amman Mineral Nusa Tenggara (a Medco Energi subsidiary) whereby AMNT got 44% of MAH shares outstanding at 0.205 AUD. AMNT got these MAH shares by exchanging around 150 million USD in equipment which they got by opportunistically acquiring their controlling stake in the Batu Hijau mine from Newmont. Since Medco Energi is an oil and gas production company, they had little experience in mining. For them the easiest way to get mining experience in house was to acquire a controlling stake in MacMahon with this asset swap.

Batu Hijau is a low quartile cost Copper-Gold mine in Indonesia which Newcrest sold due to problems with the government. Indonesia prefers that their resources are extracted by Indonesian companies. The Batu Hijau mine is predicted to run to at least 2031. On the same island as Batu Hijau is the Elang deposit, owned by the same company which owns Batu Hijau. Since the company which owns the Batu Hijau mine is busy building a smelter on Sumbawa island where the mine is located, one can assume a reasonably high chance that the Elang deposit will get developed (again a low cost copper-gold project). Combined, Batu Hijau and Elang production should run until at least 2060 according to Newcrest estimates in 2016. These mines are a good backbone for MacMahon to build their business. On top of this, the Batu Hijau contract added about 10-15 million of EBIT in their first few years, and I estimate that this amount has risen to around 20 million in recent years.

GBF acquisition

In June 2019, MacMahon announced the acquisition of GBF, an underground mining contractor for 49 million upfront and an earn out of 23.5 million. The additional earn-out of 23.5 million makes this a 72.5 million acquisition. This is about 3.5 times 2020 EV/EBITDA. The acquisition was done at a small premium (less than 6 million) to book value.

The primary reason for the acquisition was to expand their underground mining knowledge. This is necessary for the Tropicana mine, which basically kept them alive between 2014-2016, and is increasingly going underground from open pit.

So in that context, given the OK valuation and the future possibilities this acquisition brings, it is a reasonable acquisition.

With that acquisition came a pretty large contract for Silver Lake Resources, which I guess adds about 10-15 million a year in gross profit to MAH. Silver Lake is a pretty interesting client given that they are a relatively low cost small/mid cap gold miner. This is a somewhat larger margin than their average contract, and a way higher ROA (around 20-25%).

We will return to this concept of providing work for relatively low cost mines owned by small to mid cap junior mining companies (at a higher average margin).

More recently, and after the GBF acquisition, MAH aims to achieve higher margins and a 15% ROA. The key to these ambitions are some relatively recent contract wins.

These wins are for some smaller companies with favorably positioned mines on the cost curve and are entering the production phase in the coming year(s). These contracts for smaller mining companies at competitive mines should expand their margins since these smaller companies have little leverage on a contract miner, and even less when these companies are single mine companies. In contract mining, larger margins usually come at higher risks (higher risk of mine closure mostly like the Mount Morgans contract mentioned above), but the low cost profile of these recent contract should shield them somwhat from some of the usual contract miner risks. These low cost mines should provide them a relatively high certainty of work in periods of a downturn in commodity prices.

Some of these contracts for smaller miners with relatively low cost mines are:

-       - Red5 with their King of the Hills gold project (written up by yellow on this site) has an Life-Of-Mine (LOM) All In sustaining cost (AISC) of around 1000 usd per ounce.

-        -Calidus resources with the Warrawoona gold project with a LOM AISC of 925 usd per ounce

-        -Bellevue Gold, with a low decile project which is still in development phase

If we can assume that their normal projects will maintain their margins going forward and the new projects will expand their margin, then you are looking at a company with a pretty nice portfolio, decent growth prospects and an even cheaper valuation. Add to this perhaps some extra margin expansion due to the rising metal prices and few new good contracts, I can easily see a double or even triple in the MAH shareprice.

As the astute reader might have noticed, many of these smaller low cost mining companies are active in gold mining. This is because gold mining is one of the rare corners in the natural resources world where small caps can own low cost mines. Most low cost base metal mines get taken over by one of the major mining houses. I do not forsee that this revenue mix by commodity will change very much for the company going forward. An investor in MAH should be aware of this risk, but given the current macro environment I am quite comfortable with this risk.

Another gain by MAH is a few contracts on low cost (Met) Coal mines, which were previously awarded to Thiess, the world’s largest contract miner. Specifically, these are Dawson South and Foxleigh. I do not expect these contract to meaningfully expand their margins like the before mentioned contracts will do, but they do provide some revenue diversification which is welcome in this business.

An additional catalyst may be a buyback announcement from the company. MAH has hinted at this in an October 2021 press release for the GBF earnout payment. The acquisition was made with an earn-out depending on the performance. Under the acquisition agreement, the GDB vendor’s were entitled to an earn-out payment of 3X any EBITDA in FY 2021 above an agreed hurdle. This payment amounted to 23.5 million, and will be paid with 12 million in cash and remaining in shares. The company plans to purchase these shares on-market according to the 25^th of October announcement. I would not be surprised if these shares will be part of a general buyback announcement, which is quite accretive at these levels.

Catalyst

- New contracts, earning growth and (possible) multiple expansion

- Possible share buyback

- Returning more capital to shareholders

- Favorable mining environment leading to better margins and contracts