Mining services group Shaft Sinkers (SHFT) provides a lesson in the importance of cashflow. Despite the company winning new contracts, there's a brewing problem with its inability to get properly paid for work. That's a key reason behind a 25.6% fall in the share price to 16.75p.
Shares was previously a fan of the company, given its niche skills, generous dividend and ability to keep winning new business during the mining downturn. Sadly the sector problems have now caught up with the £10 million cap, leaving it in a financial pickle.
We flagged balance sheet risks at Shaft Sinkers in May following an appalling set of full-year results which saw the cancellation of its final dividend. It simply didn't generate enough profit to cover the level of dividends to which it had been used to paying.
A trading update today reveals cashflow problems which is forcing the company to up its efforts to renew borrowing facilities. This implies there's even darker days ahead for Shaft Sinkers.
The company has historically been reimbursed for any additional costs if a project is delayed due to the fault of the client. Project requirements can also vary during the construction phase, so it is normal for Shaft Sinkers to renegotiate payment terms on an ad hoc basis. It this area which is the focus of today's announcement. It looks like Shaft Sinkers is struggling to get extra money beyond initial pricing agreements, which suggests it needs greater levels of working capital.
Shaft Sinkers' existing banking facility is understood to expire in December 2014. We'd keep a very close eye on working capital in the next few sets of trading updates or financial results as this could become a problem area for the group.
The cash risks have overshadowed news of higher margins from international operations and a contract extension with Afplats. A zinc project in India is clearly behind schedule as Shaft Sinkers has terminated a subcontract with one of its suppliers and will do the work itself.
We flagged risks to the mining services sector last summer (19 July 2012 – see page 42 - warning: opens as a large pdf) when the big mining companies started to cut capital expenditure. One of our key 'sells' was Capital Drilling (CAPD) at 58.5p. This is now trading 69% lower at 17.88p. It has suffered from reduced business, resulting in a profit warning last October.
Yet a look at MDM Engineering's (MDM:AIM) latest results would suggest there are still some strong parts to the mining services sector. The company a fortnight ago reported a rise in pre-tax profit from $7.8 million in 2012 to $20.4 million. Today it has won a new contract with Hummingbird Resources (HUM:AIM) on a gold project in Liberia.
MDM had previously tried to merge with sector peer Sedgman (ADM:ASX) but that deal was called off in May. Sedgman is focused on the Australian market where there's been a considerable number of project delays and cancellations. It is also a specialist in coal and iron ore – both commodity types currently experiencing weak selling prices.