Monadelphous Group Ltd (ASX: MND) could see its share price hit its 10-year low of $4.66, if current trends continue.
In mid-afternoon trading, Monadelphous's share price is down 3% to $5.84 compared to the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) down just 0.2% for the day.
By current trends, I mean falling commodity prices, including energy. And that's despite winning a number of new contracts of late, including Shell Australia's Prelude Floating Liquefied Natural Gas project (FLNG) worth more than $200 million, and a two year contract for services on the North West Shelf's Karratha Gas Plant, operated by Woodside Petroleum Limited (ASX: WPL).
The key problems Monadelphous faces are:
- Both minerals and energy commodities prices are falling, forcing miners to drastically cut costs and the company has exposure to both
- The commodities crunch also means less explorers are active, which will have an impact in later years, when old projects mature, and there's no new projects to replace them with.
- Contract margins are being squeezed, with mining services companies lucky enough to win contracts likely doing it at very close to cost price – if they are lucky.
- Mining services companies, desperate to stay alive may well underbid contracts just to get the work.
- If the resource companies can't cut costs enough, resources and energy projects will be forced to close, or suspend operations like BC Iron Limited (ASX: BCI) was forced to do today. That means less clients and less work.
- Winning new contracts is a good sign for a contractor like Monadelphous, but even if the company provides the estimated value of the contract, that doesn't necessarily mean it will be profitable.
- Resources and energy capital expenditure is forecast to continue falling into 2017, before staging a recovery in 2018.
- Monadelphous says first half revenues are expected to be down 10% for the six months to end of December 2015 on the six months to June 2015.
Markets don't always act rationally, and we could see a period where prices for commodities mean virtually every miner is making a loss. They in turn will turn the screws on their contractors.
Foolish takeaway
Monadelphous has proven itself to be the standout mining services contractor over the past decade or more thanks to strong returns on equity and earnings growth. Unfortunately for shareholders, that's no longer enough, with the whole sector negatively affected by less work and lower margins.
Look out below.
