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Out Of Crisis Comes Opportunity

The free-falling iron ore price and Fortescue’s decision to cut back its capex commitments dropped a grenade right in the centre of the Mining Services sector. Shrapnel flew everywhere, tearing great swathes from the stock prices of anything in the vicinity. One such stock is NRW Holdings (NWH), which is involved in contract mining, civil engineering and other mining services.

It wasn’t a completely innocent bystander. Management emerged from a Fortescue meeting with $100m shaved from their FY13 secured revenue guidance.

Now that’s not the kind of figure that should be ignored. A hundred mil here, a hundred mil there and pretty soon you’re talking about real money. But it does need to be viewed in the context of the total secured revenue figure, which still stood at a hefty $1.2bn.

FY13 guidance has simply shifted from revenue and earnings growth of 15-20%, to revenue growth of 15%. At a double-digit growth rate, the stock was probably on fairly ritzy multiples, so a de-rating was likely needed I hear you say. NRW in fact trades at levels consistent with a business that is in terminal decline, or at least completely devoid of growth. It’s currently on a PE of around 5.5X FY13 and an expected dividend yield in excess of 9% – fully franked!

The 10c final divvy goes ex on the 8th of October, so almost 5% of that yield is in the bag. The 9% forecast yield suggests that this level of dividend is not going to be maintained. But given the 51% payout ratio, a dividend reduction would require NRW’s clients to hack off one of its limbs, rather than the little paper cut that Fortescue delivered.

Further major contract curtailments are unlikely. Fortescue has already taken its medicine for one thing, but more importantly, NRW’s cornerstone client is the lowest-cost iron ore producer, Rio. Needless to say, it’d take a considerably more serious demand slump for Rio to follow Fortescue’s actions. Just this morning NRW announced a $133m contract working on Rio’s Cape Lambert Port B project, which incidentally more than replaces the revenue lost from Fortescue.

The other key point is that NRW has generated a lot of cash in recent years and is not capital intensive. Operating cashflow was a hefty $173m last year for example, with free cashflow of $138m. The upshot is that the company has a very healthy balance sheet, with net debt to equity of just 18%. This means that NRW is not going to become a balance sheet story if conditions were to really tighten up. The company could in fact take advantage of such a scenario to expand through acquisition.

 But that’s all for the future. What’s important is that NRW is cheap today and will spit out a 10c dividend next month. If you want yield with fairly substantial capital growth potential, you need to take a look at this stock.

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