42% upside potential:
On today’s Breakouts report, there are 50 stocks on the positive breakouts list (stocks with positive price momentum), and 15 securities are on the negative breakouts list (stocks with negative price momentum).
Discussed today is a stock that surfaced on the negative breakouts list in late July – Major Drilling Group International Inc. (MDI-T). However, analysts anticipate the share price will rebound sharply. The stock has a unanimous buy recommendation from six analysts. The average one-year target price implies the share price has 42-per-cent upside potential over the next year.
In June, the company reported disappointing quarterly earnings results, and, at the same time, commodity prices were rolling over, putting downward pressure on the stock price. The share price has recently stabilized but remains down 22 per cent from its 2021 closing high of $10.97 reached on May 18.
A brief outline on Major Drilling is provided below that may serve as a springboard for further fundamental research when conducting your own due diligence.
The company
New Brunswick-based Major Drilling is a drilling services company with a fleet of approximately 600 drill rigs that serve the mining industry. In the fourth quarter, 62 per cent of the company’s total revenue was from gold projects, and 18 per cent of total revenue stemmed from copper projects.
The company provides three main types of services: specialized drilling, conventional drilling, and underground drilling. Given the complex nature of specialized drilling, this segment offers higher margins as well as high barriers to entry. In the fourth quarter, specialized drilling represented 60 per cent of total revenue, conventional drilling accounted for 11 per cent of revenue, and underground drilling made up 29 per cent of total revenue.
On June 1, the company completed the acquisition of Australian-based McKay Drilling PTY Limited at a cost of approximately $75-million. The acquisition is expected to be immediately accretive. The purchase of McKay will help diversify Major Drilling’s revenue as over half of McKay’s revenue stems from iron ore with most of the balance coming from gold projects. McKay has a fleet of 20 rigs.
Investment thesis
- Industry leader. The company is one of the largest drilling services companies in the world.
- Beneficiary of rising commodity prices.
- Improving profitability with gross margin recovery anticipated in the near-term.
- Stock’s valuation is in-line with its historical average. Room for multiple expansion.
- Key risks to be aware of: 1) volatility in precious and base metals prices, especially gold; and 2) skilled labour shortages resulting in higher costs and lower productivity.
Quarterly earnings
After the market closed on June 14, the company reported its fourth-quarter fiscal 2021 financial results (the company’s fiscal year-end is April 30).
Revenue came in at $128-million, ahead of the consensus estimate of $118-million, and up 44 per cent year-over-year fueled by higher gold drilling activity. This was the company’s highest quarterly revenue reported since 2013. However, margins compressed. The adjusted gross margin was 18.4 per cent down from 20.3 per cent reported last quarter and 21.5 per cent reported during the same period last year.
In the earnings release management said, “Margins were impacted by increased training costs and significant ramp-up costs due to rapid growth in certain regions. There were also some COVID-19 related shutdowns in the quarter, which generated mobilization and demobilization costs, as well as additional standby labour costs to retain skilled drillers through the shutdown periods.” EBITDA (earnings before interest, taxes, depreciation and amortization) came in at $12-million, falling short of the consensus estimate of $19-million. The following day, the share price declined 6 per cent on high volume with over 1.3-million shares traded, well above the three-month historical daily average trading volume of approximately 600,000 shares.
In the earnings release, president and chief executive officer Denis Larocque provided a bullish outlook, “Looking ahead to fiscal 2022, we continue to see a noticeable increase in inquiries from all categories of customers, and if their plans progress as advertised, we expect to see utilization rates continue to improve as crews become available. Although the shortage of experienced drill crews will put temporary pressure on labour costs and productivity, especially in our most active markets, we expect the wider industry shortages and higher utilization rates to continue to drive a more positive pricing environment and expedite margin recovery as the cycle progresses. Further, as pandemic restrictions ease in South America, we expect to see an increase of activity as drilling programs resume in Chile and Argentina. With gold’s average mine life falling to a low of nearly 10 years due to the lack of exploration over the last six years, industry experts expect reserve replacement to be a top priority for gold companies for years to come. As well, although we have not seen much of an increase in activity from base metal players, copper prices have recently hit historical highs, which should also translate into more exploration activity in the near future as mining companies seek to replenish depleting reserves. At the same time, we have seen governments across the world unleashing significant stimulus programs targeting renewable energy and electric vehicles, which will require a huge volume of copper, as well as battery metals.”
Dividend policy
The company does not pay its shareholders a dividend.
Back in 2016, the company discontinued its dividend.
In a news release issued in 2016, Mr. Larocque said, “The company’s board of directors has decided to suspend the dividend. The company intends to use these funds to better prepare itself to adequately respond to a future upturn in the mining industry and to emerge as one of the strongest drilling companies.”
Analysts’ recommendations
This small-cap stock has a unanimous buy recommendation from six analysts.
The firms providing research coverage on the company are: Beacon Securities, Laurentian Bank Securities, Paradigm Capital, RBC Dominion Securities, Stifel Canada, and TD Securities.
Revised recommendations
Since the beginning of June, two analysts have revised their target prices.
- Paradigm’s David Davidson increased his target price to $13.50 from $10.50.
- TD Securities’ Daryl Young trimmed his target price to $12.50 from $13.
Financial forecasts
According to Bloomberg, the consensus revenue estimates are $568-million in fiscal 2022, up from $432-million reported in fiscal 2021 and $614-million in fiscal 2023. The consensus EBITDA estimates are $89.6-million in fiscal 2022, up from $53.9-million reported in fiscal 2021, and forecast to rise to $108-million in fiscal 2023. The Street is forecasting earnings per share of 41 cents in fiscal 2022 and 50 cents in 2023.
In recent months, earnings expectations have been rising. For instance, three months ago, the Street’s fiscal 2022 estimates called for revenue of $495-million, EBITDA of $81-million, and earnings per share of 36 cents.
Valuation
According to Bloomberg, the stock is trading at an enterprise value-to-EBITDA multiple of 7.9 times the fiscal 2022 consensus estimate, in-line with its three-year historical average multiple of 7.8 times.
Over the past three years, the stock has traded at a forward EV/EBITDA multiple ranging from under 4 times (bottomed in the first quarter of calendar 2020 when markets tumbled) to a peak multiple of around 11 times.
The average one-year target price is $12.25, implying the share price may appreciate 42 per cent over the next 12 months. Individual target prices are: $11 (from Laurentian Bank’s Ryan Hanley), $11.50, $12, $12.50, $13, and $13.50 (from Paradigm Capital’s David Davidson).
Insider transaction activity
Year-to-date, relatively small trades in the public market have been reported by insiders. These transactions are listed below.
Most recently, on July 12, vice-president of operation in South America Ashley Martin purchased 595 shares at a price per share of $8.09, increasing his position in this specific account to 3,165 shares.
On June 23, director Jo Mark Zurel exercised his options, receiving 6,000 shares at a cost per share of $7.04, and sold 6,000 shares at a price per share of $8.80, leaving 60,000 shares in this particular account.
On June 22 and 23, chairman David Tennant exercised his options, receiving 6,000 shares at a cost per share of $7.04, and sold 5,000 shares at an average price per share of approximately $8.75. After these transactions, this specific account held 193,100 shares.
On June 17 and 18, director Juliana Lam bought a total of 6,000 shares at an average cost per share of roughly $8.915, initiating a position in this particular account. Ms. Lam was appointed to the board of directors in 2020.
Chart watch
Year-to-date, the share price has increased 12 per cent. However, the share price is trading well below its 2021 peak.
On May 18, the share price closed at $10.97 - its highest level since 2013. Since then, the share price has nosedived, falling 22 per cent from this multi-year high. In June, the company reported weaker-than-expected quarterly earnings results and commodity prices were rolling over.
The stock appears to have bottomed, rebounding 9 per cent over the past nine trading days.
In terms of key resistance and support levels, the stock price has a major ceiling of resistance around $11. Looking at the downside, there is strong technical support around $8, just above its 200-day moving average (at $7.67).