Master Drilling (JSE: MDIJ)

Financial Analysis on Master Drilling. Buy/Hold/Sell?

About

Master Drilling is one of the largest rock boring and drilling services providers in the world. The company was founded in 1986 and is based in Fochville, South Africa.  It operates in Africa, Central and North America, South America, and internationally. 

Master Drilling challenges the status quo by providing an end-to-end portfolio of specialised, adaptive, and integrated services. Master Drilling is not the mining company nor the seller of commodities but merely proving the equipment and drilling services required by mining companies. Its operations include:

Rock Boring: Master drilling owns a raise boring fleet of over 140 rigs - the largest in the world. It includes raise, horizontal, box hole, slot, reef, mobile tunnel, and blind shaft boring systems. Their larger diameter rigs are able to drill depths up to 1.5km.

Exploration drilling: Master drilling offers a fleet of specialised drill rigs capable of supplying drilling services across the exploration drilling spectrum, including aircore, blast hole, core, grade control, hydrogeological, mud rotary, percussion, sonic, and underground drilling services.

Support: Master Drillings service division provides design, engineering, manufacturing, customization, maintenance, and geological support for all its drilling activities. 

Revenue distributions

Geographical revenue distribution: Africa 38%, South America 32%, North Americas 11%, other countries 19%.

Commodity revenue distribution: Gold 27%, silver/lead/sinc 26%, copper 18%, PGMs 13%, Nickel 5%, 3% iron ore, 3% diamonds, 8% the rest

Technical Analysis

Figure1: Represents the 1-year chart. The trend is bullish, but it looks like its forming a rising wedge pattern, which is normally a bearish signal. The RSI is trending down towards its bull-trend support level of around 50.

Figure2: Represents the 5-year chart. The share price trended downwards between 2017 and 2020 from its high of around 1800c to its low of around 500c. From May 2020, the share price has been on a tear, increasing all the way to its current level at around 1400c. Once again, the RSI is approaching overbought levels in the 5-year timeframe.

Overall, the technical analysis does not provide an obvious buy/hold/sell answer. If anything, it suggests that we might be due for a correction in the short term. It is a small-cap, however, with a very low P/E ratio, and thus I will put much more weight on the financials and the overall outlook for the company than on the share price chart.

Financials:

As reflected in its share price, its clear that the company did exceptionally well in 2021. If we look at the income statement, 2017-2019 were very stable. Revenues, EBITDA and net income remained stable every year, yet the share price kept tanking. This is likely due to a lack of growth and/or not delivering on analyst expectations. 

In 2020, the pandemic hit, and with it, revenues slumped. The share price, however, started to regain momentum. I believe this is because investors knew that operations would resume at some stage and because the company was then trading at an extremely attractive P/E and share price valuation.   

I will focus on 2021 figures and try to provide answers for this growth, given the fundamentals of the company and the macro influences.

Revenue: Revenue increased 40% in 2021 $172M. Except for revenue, the rest of the line items in the income statement remained relatively unchanged, which means that the revenue increase led directly to an increase in net profit. Net profit increased from $3.3M to $20M. 

Other margins: Gross margin 28.3%, operating margin 16.8%, net profit margin 11.6%. EPS $0.13 (from $0.02)

The balance sheet remains intact. One super positive figure for Master Drilling is its low debt levels. The company operates with a quick ratio of 1 and a current ratio of 1.38, which means there are enough liquid assets to cover current liabilities. Debt to Equity is only 22.23% which means low current finance cost, and it leaves the door open for future debt acquisition to invest in more PPE or investment projects. 

Variables to consider

Small-cap: Despite its bullish run over the past year, Master Drilling is still only at a R2.1B market cap, which puts it well and truly in the small-cap category. Once again, despite its growth, its P/E is only at 6.76 and the company even pays out a dividend at a yield of 2.36%.

Product: In a gold rush, buy shovels instead of gold. Master Drilling provides the assets necessary to mine all sorts of commodities. Of course, our reliance on commodities to produce isnt going anywhere, which means the company operates in the right industry.  

Commodity cycle: As with any company in the commodity sector, cyclicality plays a big role in performance. Revenue equals price times quantity, and the price of commodities does tend to be volatile. Master Drilling, however, is not a commodity producer and seller, but merely provides the infrastructure required to mine these commodities. They are therefore indirectly exposed.

Commodity prices worldwide have skyrocketed in recent times due to Covid and the Russian-Ukraine war which led to sanctions and supply chain issues. I do believe we still have runway in the short-term, but prices will eventually cool down which will negatively affect revenues. 

Technical analysis: Technically, we are due for a correction in the share price, but I underweight that assumption due to the company being a small-cap and the financials looking strong.

Financials: Can Master Drilling keep growing when commodity prices damper down? I do believe so. In 2019 and 2020, the company acquired many new rigs, but these rigs were mainly underutilised, until now. Mining companies, in general, have picked up production which has led to a direct improvement in Master Drillings order book. This means that future incomes are being locked in. 

As stated above, revenue equals price times quantity. There is nothing that Master Drilling can do regarding commodity prices, but it can expand its operations to increase its output, which is a much more generic growth driver for the long term.

Intrinsic value: We believe there will be one more leg up before a potential correction. Therefore, FinMeUp will take a small position now and reconsider my position around R17-R20 per share. Liquidity can be an issue when trading small-cap stocks which means that spreads are bigger than normal. Always ensure that there is sufficient liquidity when trading these shares, especially in South Africa.

***Disclaimer: Just a friendly reminder - This is not financial advice. Always do your own research before taking a position. Content is for informational and educational purposes only***