Contracting and services companies generally provide outsourced services to businesses such as plant and equipment maintenance and contract mining (in other words – the actual digging, drilling and transport of the ore, and processing of the ore). Given businesses could do many of these roles themselves, but choose not to, most of the providers tend to operate on very slim margins, and can be very sensitive to business cycles.
Here are some factors to consider when you are looking at company reports this earnings season. Leighton Holdings Limited (ASX: LEI) reported this morning and gives a nice example to use as we look at the factors that can affact these types of companies.
Profit Margin. When looking at these types of businesses, one of the first things we want to know is whether their margins have improved or fallen. Leighton has reported a profit of $105m earned on more than $6 billion of revenue, which suggests the company's margins are very thin indeed, and when compared to last year, have dropped significantly.
Work in hand / contracted order book – Additionally, we also want to know how much work they have been contracted to undertake, although beyond a certain point it becomes less important. As an example, Leighton has more than $47 billion of work in hand. In that company's case, we'd want to know if that had changed much over the last year, and from their report, it appears that they picked up more than $3 billion of work in the last six months.
Geographic and customer diversification – Is the company exposed purely to one customer in one location, or does it have many customers in many locations, including globally. With commodity prices falling, heavy exposure to the resources sector could mean that earnings could fall this year and in the near future. As an example, Leighton reported a $1 billion fall in revenues since December 2011, with its contract mining services division losing almost half of that.
Debt aging – when are the rollover dates? If debt maturities are spread over a number of years, the risk of default is much less likely than if debts mature within the one year. Leighton appears to have its debt spread over a number of years, with some debt maturing from later this year, out to 2018.
Outlook – While this year may have been a tough year, we'd like to know how the companies see the next year, in terms of the contracted work they have for the year ahead, and if the companies provide any guidance for the next year's earnings. Leighton reported that its was still on target to report net profit of between $400-$450 million for the 12 months to December 2012, suggesting the second half of this year will be an improvement over the last six months.
The Foolish bottom line
Leighton is the first services company to report this season. We'll see how its competitors such as Transfield Services (ASX: TSE), United Group Limited (ASX: UGL) and Downer EDI Limited (ASX: DOW) are faring later this month.
Click here to check out our introduction to this series, and to read our other previews on other sectors of the market.
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Motley Fool writer/analyst Mike King owns shares in Leighton. The Motley Fool's purpose is to help the world invest, better. Take Stock is The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it's still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
