DDH

From Tony’s Pulled Pork, Episode #547, Dec 2022:

Okay. So, I came across this one. I think it’s been on the buy list on and off now for a while, but it came on again this week, so it caught my eye. I’m not too familiar with DDH, and DDH is the code; DDH1 LTD is the name of the company. But when I did a bit of a quick look at what they do, they’re a drilling company. So, they provide drilling rigs to the mining industry, both above ground and below ground. This particular company has four brands now; it has DDH1 drilling, Strike drilling, Ranger drilling, and a new acquisition called Swick. I’m pretty sure that Swick was on our buy list in the past as a standalone drilling company and there was a scheme of arrangement takeover. So, kind of a merger, or kind of an acceptance by Swick that they would accept the offer from DDH. So, Swick is now part of DDH. So, it kinda makes sense DDH is now on the buy list because a large part of the company is Swick. But anyway, the new combined company which includes Swick is quite large in terms of the drilling space; it operates overseas and in Australia. For what it’s worth, that have a hundred and eighty-three drilling rigs, which puts them into the top five globally for drilling companies, and number three by revenue. So, it’s getting quite large now. And that makes sense, because the mining industry in Australia is quite large. There’s Australia, Canada, a bit in the US, a bit in Africa. So, you’d expect an Australian company to be large on the global stage. This one is. A couple of other things to note about them: they’re based in Perth; they have a share buyback underway. So, as we’ve seen with some of the coal companies that we’ve analysed recently, lots of these companies are throwing off so much cash they’re trying to find new ways to get it back to shareholders, and DDH is no exception. Even though it’s a mining services company, its throwing off lots of cash and there’s a buyback which has just started and underway, which should support the share price. That’s pretty much it. Large company. I will get to risks later, so I won’t talk about the risks now, but drilling companies can have a problem when the mining cycle does turn down. So, Warren Buffett always talks about finding the key metric for an industry and then judging companies based on that key metric, and his example is the airline industry. He talks about what he calls the heavy lifting KPI, which he quotes for the airline industry as being revenue per seat per kilometre flown. So, he tries to summarise all the metrics for a company or an industry into one ratio. I don’t have one for the drilling industry, but it would be something like the utilisation capacity per drilling rig. And what I mean by that is, the drilling companies can make money by getting lots more drilling rigs and hiring them out, but they can also make money by making sure those drilling rigs are used to their fullest capacity. So, drilling rigs can be underutilised if they’re back at the base waiting to be deployed to another mining site or there’s some kind of problem with the mining site, like a flood, and they can’t use the drilling rig for a while. So, utilisation is a key metric. And my only point being that, now that mining is going through a bit of a boom, utilisation rates are high. But I have seen in the past, this is a risk for the industry, that when the mining industry goes into a downturn suddenly and very quickly — which I guess suddenly means — but suddenly the drilling rigs can be underutilised tremendously. So, there can be, of the hundred and eighty-three they have now, if half of them are sitting without contracts, that’s going to be a big drag on the company. Or if the other half are used for four weeks on and off, then that’s a huge drag on the company. So, this particular company will have experience at managing that, but it’s something to bear in mind if you’re a long-term investor in this kind of company. So, by the numbers, the share price I’m doing this analysis on is 90 cents, which is less than the consensus target for what that’s worth. It’s greater than IV1 but less than IV2, so that scores for us; $1.10 is IV2 for this company. It’s also less than book plus 30%, so net equity per share for this company is 85 cents. So, you’re basically buying these drilling rigs almost dollar for dollar, which is a good thing. The average daily transaction size for this company is $628,000, so it’s a reasonable size and should suit a lot of people listening. Strong yield for this company, 5.73%, but just not quite enough to be above the bank mortgage rate, which is just a tick over 6%. So, it doesn’t score for us there. Stock Doctor financial health is strong and steady, and it’s also a star stock. So, they also rate this company, so it scores well on all those kinds of metrics. Pr/OpCaf is only 4.3 times. So, not only are we buying dollar for dollar for the drilling rigs, but we’re also paying no more than four and a half times cash flow for this company, which is pretty amazing for any business which is strong and growing, and number three in the world in its industry. So, it just boggles my mind that we can pay that little for it. Growth for the company is strong, it’s growing at 15% earnings per share. And the PE is just a little bit over seven times at the moment, and that’s the lowest in the last three years. So, it scores for that. But growth of 15% over PE of 7 is just a little over two times for our growth over PE metric, so it scores well, because our hurdle is 1.5 times, so it scores well for that. And a really good thing I think is that directors hold 13% of the company, which is mainly concentrated in one of the founders of the company, a co-founder, a guy called Murray Pollock who owns around 12% of the company. So, that’s a big thing for me, I like that a lot. So, if anyone’s going to be able to manage the cycle in mining in terms of, you know, scaling up and scaling back the drilling rigs in use someone, like that who would have seen it all will have a good handle on how to do that. The company is a new three-point upturn, so it scores for that on the graph. Consistently increasing equity, so it scores for that. So, all in all, really good on the numbers. A quality score of above 100%; 113%, because some of those things score two points, and a QAV score of 0.26. So, it’s reasonably high on the QAV buy list for us. I did just want to address some risks, though.

So, the company has called out the fact that the labour markets can contract, and so access to labour is an issue; especially because we’re don’t yet have all of the immigration that we used to have before COVID. And also, too, wage costs are going up, so that’s going to be a risk for them. Inflation is also biting them in other areas, they have costs, and they need to pass those on. The contracts, according to them, are structured to do that, but that’s going to be a risk if they do have an element of fixed pricing in their contracts and inflation causes their costs arise that will be a problem. And then the last one, which is a big one in the industry, is what they call rig availability. So, if they wanted to buy a new rig because they get a new contract, there’s currently a twelve-month lead time for above-ground rigs. So, it’s difficult for them to source new rigs to fulfil new orders. That’s been somewhat mitigated by the purchase of Swick which does have a manufacturing arm, even though at the moment that’s tooled up to manufacture underground rigs. They can produce a new rig within eight weeks for underground contracts, so they can seriously bring down that pipeline for new rigs, at least in the underground space. And Swick is also a good match because underground mining tends to happen when exploration has finished, the mines being commissioned, it’s drilling underground, and so that’s one part of the industry. To date, DDH and the above ground drilling tends to cater more for exploration. So, you know, the mines trying to expand, its putting rigs out into the desert outside of the mine, and they’re doing testing for where to expand the mine into. So, Swick provides underground drilling rigs and the old core business provided above ground drilling rigs. That’s a good fit. The fact that Swick can manufacture underground rigs quickly solves that part of the puzzle for a large part of their business, but I wouldn’t be surprised if they are able to change what Swick does to quickly provide above-ground rigs, manufacturing for above-ground rigs as well. It’d be an opportunity for them. But they’re the risks, and like I said before, utilisation during a downturn is a big risk. You don’t want to be holding on to all this expensive equipment and having your customers fall away quickly.