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One For The Radar

Campbell Brothers (soon to be called ALS) provided its usual earnings guidance at its AGM this week. The company expects a strong first half, followed by slower second half growth. Such commentary wouldn’t normally be viewed particularly negatively, but in this case the stock was smacked down like a cockroach at a tea party. The problem is that while Campbell’s minerals labs currently have no shortage of work, the admission that client activity is slowing has investors concerned that earnings could have peaked in the Minerals division.

Compounding the negative sentiment is the clear change in tack from the major mining companies. BHP and Rio are certainly less gung-ho about volume growth and more focussed on efficiency gains with commodity prices no longer at record levels.

At the lower end of the scale, junior miners are running into a funding headwind. Capital raisings from the junior explorers, for whom debt is typically not an option, have fallen considerably in 2012. This is important to Campbell Brothers because its minerals labs are dependent on exploration activity, the bulk of which is undertaken by the little guys hoping to find a deposit that’ll propel them into the big league.

Campbell Brothers isn’t solely focussed on the Resources sector, but it is still almost half of its business. So if there is a significant pullback in activity, the largest part of Campbell’s business is at risk of contraction in the next couple of years. The stock still trades at a premium valuation, even after the recent fall, which may not be justified in such a scenario.

With regards to the rest of Campbell’s business, management has been actively diversifying into other areas such as food and pharmaceutical lab work. This is a sensible strategy. The testing of food is a growth area which is likely to become much more significant for Campbell over time. Pharmaceutical testing is a more mature market, but the industry is fairly fragmented, which should provide acquisition opportunities. Both of these industries are considerably less cyclical than minerals.

Campbell Brother’s balance sheet is in good health and with its DRP re-enacted, expansion through acquisition is a viable option. Management has a good track record on this front. The threat to group earnings from declining minerals activity will be much reduced if they can get one or two accretive deals locked away.

Exploration funding could also be quickly turned back on if Europe gets its act together, the US recovery steps up a notch (or gets fired up by the Fed) and the old “China hard-landing” fears remain unfounded.  Should this transpire then Campbell Brothers is cheap right now, but given the weight of negative sentiment towards the stock and the sector right now, there’s no urgency to rush to such a conclusion. This is certainly one for the radar though.

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