Mitchell Services Limited

Good morning, everyone, and thank you for joining us today for the Mitchell Service half-year result. My name's Alan Chan from Bridge Street Capital. Joining us from the company, please welcome Executive Chair Nathan Mitchell, CEO Andrew Elf, and CFO Greg Sotala. We will have a Q&A session at the end of the presentation, so if you could enter all questions into the Q&A, and I'll address them The webinar is being recorded and will be circulated afterwards. On that note, Andrew, over to you. Thank you.

All right, Alan, thanks very much for the introduction, and thanks very much, everyone, for joining us today and for the interest in the company. I'll move straight to slide four, the market profile, and just take the disclaimer as being read. Obviously, there you can see the shares and market cap and major holders. Obviously, Mitchell Group being Nathan Mitchell and Dream Challenge, Scott Tunbridge, another one of our non-exec directors. Just moving on to slide five, the summary for the first half. Look, a very good half for the business and significantly improved half on half year on year when looking at EBITDA through to profit after tax and return on capital. And certainly, I think as Greg goes through the financial slides, he'll It'll certainly provide some additional colour on what's driving those improvements. Also, and importantly, down there in the middle, the winner of a prestigious National Safety Award, which I'll touch on again a little bit more in a moment. So just on slide six, the overview, obviously the high prices for commodities are still driving demand for drilling services, particularly for highly skilled drilling services, either mine services work or depot work or specialist type work of different natures. So we say here that inflationary pressures are continuing to ease. Really best to break that up into two parts to give it a little bit more colour, one from a labour perspective and two from an inputs perspective. We also make the point there that the market in exploration has softened a little bit. So you've sort of seen lithium and nickel come off. I know a small drilling company up in Mount Isa called Tull has gone into administration. Another drilling company up in North Queensland is selling some rigs and reducing their size. Junior capital raising's not bad through November, December, but down in January. It's obviously the wet season too, so things are a bit slow in that space. So certainly when you then look at some of those things that are happening and take it back to how labour's looking, Certainly, what we're seeing with labour is less pressure than what we have seen in the past, and certainly from more the senior employee perspective, we wouldn't anticipate any great movements in labour expense into the future. Obviously, it's going to be more lower end in what Fair Work decides to do. From an input perspective, certainly a big input cost for us is drill rods and things that are made of steel, and those prices have been fairly flat. things like that. So all in all, from an inflation perspective, the outlook for us is certainly a lot better than it has been. And then obviously that exploration market is not a large part of our business. Obviously a majority of our business, as I say there, is with the global mining majors on their mine sites. And so certainly that being the case with commodity prices, they're certainly very busy. The revenue split, a bit more of a movement towards the surface, a little bit of a change in mix of work. Gold still that's circa 40% of the book roughly and as I said there 80% of the work is predominantly mine site related. So we're still quite busy and looking like it's going to be another good half for us in the second half and importantly as well we've got no exposure to lithium ore or nickel in the business so that hasn't impacted us whatsoever with some changes there. Just operationally on seven. The surface fleet, effectively booked out, demand is strong, and again, as I said, those people that are producing and making good money and they're very busy. Rigs that we have got available to us are predominantly underground rigs. They're obviously a lot smaller, don't invoice as much, and it is a more of a, generally, a more of a commodity-style drilling, still aspects of specialist drilling. So rig count in that area does increase and decrease in the ordinary course of business. We've had a few come off in Victoria, and then post these results, also 31 December, this year so far, there's been a couple heading out again. So all in all, we expect that rig count and demand for services to remain strong. We talk about rainfall. There's been rain around, but we've been fairly lucky so far. It hasn't really hit us where it hurts, which is good. And that's obviously driven that performance in regards to either DAR and down to the MPAT line as well. In regards to that safety award, it was the National Health and Safety Team of the Year Award, a very prestigious award. And importantly, against all companies from all industries and organisations of all sizes. So we're certainly up against some of the big boys and girls and a great win for our team and really talks to some of the great things that we're doing. And I'll hand over to Greg first.

the financial slides. Thanks, Andrew, and morning, everyone. Looking at the profit and loss on slide eight, the company has produced a strong first half result with earnings leverage beginning to play out. EBITDA increased by over 20%, $20 million for the half, with improvements driven from increased margins as opposed to top line revenue growth. The margin performance was driven by a variety of factors, most notably the absence of adverse weather conditions a favorable shift in the mix of work, and recent price increases across the contract book. The most significant improvements, though, were below the EBITDA line, with a company reporting earnings before tax of $6.2 million, significantly improved versus the circuit break-even position of the prior period. The $6 million improvement reflects the $4 million EBITDA improvement, as well as material reductions in depreciation and interest costs, as debt levels continue to decrease and CapEx levels continue to normalize. And I'll touch on both of those points as I move through the presentation. Looking at slide nine, increased pre-interest and tax earnings together with the normalizing asset base represent very favorable conditions for significant return on invested capital numbers. And we've certainly seen that in 1H24 with return on invested capital over 15% up exponentially versus 2% in 1H23. We expect to at least maintain these ROIC levels as the business continues to allocate CAPEX sensibly in accordance with capital management objectives that Andrew will outline later in the presentation as well. Slide 10, looking at the balance sheet, the solid first half profit performance has meant that the overall balance sheet has remained strong. Importantly, given the relatively stable operating rig count and the usual seasonal dip in December, has meant that the working capital position in December of $20 million was significantly improved versus the $27 million position in June. This $7 million improvement has driven material increases to cash flows and significant reductions to net debt, which I'll also highlight as we move through. From a cash flow perspective on slide 11, the company generated operating cash flows of over $24 million in 1H24. at an EBITDA to cash conversion ratio of well over 100%. This exceptional performance was driven largely from three factors, being the improved EBITDA performance, the significant working capital improvement as highlighted on the previous slide, as well as a 30% reduction in interest costs given the rapid debt reductions over the same period. Worth highlighting too, as we've pointed out previously, that the business doesn't expect to pay income tax until at least the end of FY25, having benefited from the recent ATO instant asset write-off program. Looking at slide 12, I touched earlier on the significant debt reduction, and that's certainly highlighted on this slide. Net debt is essentially halved in six months from $17.6 million in June to $9.1 million currently. Almost all of the debt is traditional equipment finance, a pricing that was fixed prior to the rate rises. And that's highlighted in the blended average cost of funds figure being circa 5.7%. On a net debt to trailing EBITDA basis, leverage has now dropped to its lowest level in recent times, being 0.25 times. We do make the point there that given the upcoming dividend in March and the seasonal working capital requirements associated with increased activity levels post-December, net debt will likely increase in the short term. However, the company remains on track to reach its June 2024 net debt target of no more than $15 million. And finally, for me, just in terms of CAPEX on slide 13, the company remains committed to its capital management strategy, which includes the application of sensible limits to growth CAPEX. In line with the strategy and following the completion of the organic growth strategy, overall CAPEX levels have begun to normalize in recent years. with 1H24 CapEx of $9.7 million, largely in line with the expectations and slightly increased versus 1H23 levels. Given the relatively high level of utilization across the business, maintenance CapEx continues to support high levels of availability across all equipment. And we do make the point there finally that any second half CapEx requirements will be expected to be funded through cash.

Thanks, Greg. And just to touch on what Greg's saying there, obviously we're on track to hit that $15 million net debt target, even with cash funding at CapEx in H2. From the capital management side of things, we have said to everybody that dividends from earnings and buybacks from surplus equipment sales. And again, just looking at that number at the bottom point there, given the final divvy from 23, this interim that's upcoming, And buyback so far, we've returned $13.2 million to shareholders. And I'm sure when we get to the question time, Nathan will have some comments to make on his view in regards to capital management into the future for the business. Just on 15, looking at that capital management performance there, we've really touched on all of this, but really some fantastic numbers heading in the right direction there. We're disciplined and we're rewarding our shareholders and we're reducing debt. The balance sheet really is starting to look like a decent business now, and that's really going to give us some fantastic options as we move forwards into the future. So in summary on 16, again, $20 million EBITDA and $4.3 million NPAT, respectively. The strong commodity prices for the clients that we work for are still driving strong demand for drilling services. I didn't talk about the history of the company in the introduction today, but again, it's a quality brand with a long history and very high quality revenue streams. The global major miners and existing producers are still busy. Inflationary pressures, better than they have been. Net debt significantly down. Shareholder returns up. And again, solid return on capital, as Greg said, and net profit. And importantly there, we're saying that the earnings levels in 24 are going to exceed 23. uh we're obviously covered by q value and morgan's so for those on the call that aren't aware of that i'd certainly point you in the direction of of those reports to have a read off thank you alan and we've opened up to questions please fantastic thanks andrew uh thanks greg

So people on the call, if you can, there are some questions you can answer into the Q&A and then we can address them as they come up. Dave, first question from Daniel Saini. Employee costs were down half and half. Can you provide some colour on the drivers there? Greg?

Can you hear me?

Yes.

Yeah, look, I think probably just the function of the mix in revenue and perhaps a slight drop in sort of overall utilization. I can't think of anything sort of under, there's certainly no underlying cost decrease from an employee cost perspective. So I dare say just reflective of the change in mix of work and single shift, double shift mix as well.

Yeah, and all I'd add to that is I think that we've been very disciplined with our overheads. The business is... you know, being run well and managed tightly. And certainly those overhead labour costs are well in control too.

Thanks, guys. Maybe one from me to Nathan. Can you maybe highlight the growth strategy going forward or the long-term prospects, I guess, sort of drive that top line?

I think that overall the strategy has been spot on. I think year on year now, this is probably another good year to give a return to shareholders. I think certainly we've had a lot of growth and I suppose the market expects to see more growth. But I think at this stage, like we said last year, we've sort of changed tact and not changed tact, but essentially spent the money on growth on those rigs. And now we're sort of repaying those profits and dividends back to shareholders. But we'll continue to look for growth. I think the market in the juniors is softening. We know that. I think there's less income coming into the juniors. Doesn't affect our business as much as it does probably the junior drillers. But certainly we're seeing a change there. We probably anticipated that as a strategy years ago. that's the reason why we stayed in coal it's the reason why we stayed uh with the majors and um and again i think it's it's it's delivering when others uh are i think west australia is obviously still fairly strong um but uh east coast is changing on the on the juniors and the gold front but from a growth point of view we're always looking for growth we're certainly looking for opportunities all the time but uh we're in no rush um and i think we've seen that over the last five years we're really on our own timeframe and our own time horizon. And so far, you know, the steps we've been taking have been the right steps. And, you know, we'll always look for new opportunities. I think we're being approached daily from small drilling contractors to buy. It's not a great sign for the juniors, but fundamentally we're in a pretty good position. So I think, as I say, if there's, new contracts coming and we need to invest in CapEx. If they make sense, then we will. If they don't, then we'll just continue with what we're doing at the moment. Thanks, Nathan.

Another question from Daniel. The ongoing maintenance CapEx budget of 15 mil, does this include budget replacement upgrades of some of the rig fleets? And if so, how many rigs will be replaced each year? And what is the average lifespan of a rig?

Yeah, look, it's a difficult one to answer because there's different types of rigs conducting different types of work and life on one, even though you might have the same rig, the life can be significantly different depending on what it's doing. So the best way to think of it is the rigs will last a long, long time, well in excess of 10 years and they just get rebuilt and they go back out again. But at the same time, you're constantly selling this and buying that and you know, in the ordinary course of business. And certainly, you know, from our perspective, that's something that we will continue to do. I probably think, you know, looking forwards, you know, you're not going to be a capex of 15 million, you know, moving forwards. I think probably 17 and a half, Greg, you know, plus minus is probably a reasonable number to sort of work from. But there'll always be rigs getting bought and sold. And generally you do, I don't know, maybe two or three a year, Nathan? Yeah, maybe. You might buy two or three new ones and sell a couple of old ones and that sort of thing, and then you've got your maintenance capex that's ongoing too. And as Nathan said, if something comes up that's interesting and meets your investment hurdles, you might buy a handful of rigs and allocate it to growth capex if it's a good opportunity. But that's probably the best way to answer that one. But really, you've always got rigs coming in and getting rigs those sort of things and really there's no big capex flow out coming. It's just not. It's just seven and a half in the ordinary course of business maintains the fantastic fleet we've got. It's available for us to use and generate earnings.

Thank you. Another question from Tom. At times you've provided guidance frames in the past. Momentum appears solid. Is there any reason why you're not, sorry, why you're providing FY24 directional guidance that is high revenue and EBITDA as opposed to range?

You want to answer, Nathan?

You want me to answer? No, I think, you know, guidance is such a difficult situation in this industry. And to be honest, it's only a negative. We had this conversation yesterday in the board meeting and being honest and open here and that is that you give a guidance and essentially you lose a contract when the weather comes and really it's only a negative guidance and we could do better. We could give guidance on the upside but it could change overnight and so you just get hit by that. You know, so essentially your guidance is really on the downside. And so in this industry, it's just, I think, too difficult and too risky to give guidance. I think the best thing we can do is just run our business well and run it properly. I think QValley and Morbids have done an excellent job on the research to date. And, you know, I think Our job is to run the business as well as we possibly can and deliver back for shareholders via either growth, dividends or debt reduction. That's our focus, really.

Thanks, Nathan. A question from Neil Watson. Can you comment on the expectations for utilisation of the underground fleet, which dropped off in the first half?

Yeah, look, I mean, all we can say is, you know, we've said that we've got 98 rigs in the fleet. You know, there's five rigs there that are old and I dare say will get scrapped at some point in time. So you've got an effective fleet in the business of 93 rigs is the best way to look at it. And then obviously you sort of go, okay, well, what is the average operating rig count, you know, as a percentage of 93? You know, we've sort of been in that, 70s type range, sort of in low 70s, mid 70s, high 70s. That sort of level on 93 rigs is about 84% or so, 80%-ish utilization, which is a decent number. So really looking at that underground market, that's where we've got some idle capacity. Obviously, the BD teams are targeting some opportunities in that space. But I certainly can't sit here and say this is what the number is going to be. Hopefully higher. And as I said during the presentation, we had a couple of rigs go out at the start of the year too. So main thing for me is if that number stays up in the 80s, then this business is going to generate some good returns for the shareholders.

Thank you, Andrew. We'll just lead into the next question from Tom. Are you expecting any asset sales in the second half what asset proceeds are still available for allocating to the buyer?

I'm happy to take this one. We do have a couple of older rigs in the fleet that are due one of those significant end-of-life rebuilds, if you like. So the potential for a sale on one of those is always looked at. At this stage, we wouldn't necessarily say we're expecting to sell them, but, you know, constantly something that's being looked at. In terms of existing proceeds available, we're down probably to about a couple of hundred thousand, to be honest. And that's sort of reflective in the sort of volumes that you're seeing with the buyback currently, which for the short term, we'd continue to, you know, to look to continue to allocate there at the same sort of levels given the As I said, there are only about a couple of hundred thousand dollars worth of proceeds still remaining.

Yeah, and I think just further to Greg's comment there that I think excess asset sales are done, to be honest. It's a case now of you might sell one, but you might buy one, or you might sell one and you might get something else. And I think really on the basis that the excess asset sales have been completed, It's something for Nathan and the board to consider in due course. The allocation of shareholder returns, obviously up to 75% of NPAT. Again, it's up to Nathan and the board to decide how they want to distribute that once those funds that Greg mentioned there have been exhausted. But certainly with the share price where it still is, I think the view is that it's still undervalued, Nathan, and attractive to buy back.

Yeah, I think this year we've allocated the full 75% of NPAT to dividends. But I think we'll continue to look at that next year and next quarter and next half. And again, from our point of view, it's really the four pillars, debt reduction, growth, dividends and buybacks. And really, it's just a matter of working out which and one of those that we want to allocate more or less to. But this year we wanted to commit to the 0.75% of NPAT. We wanted to give that back. We wanted to be able to prove what we said we were going to do, and we've done. And then going forward, let's see where the market goes, see how the market reacts to today's announcements.

Thanks, Nathan. Are there any new commodities or geographies that you're looking to get into at the near term?

We're always actively looking for opportunities. We're certainly not rushing into new commodities as such, I wouldn't say. and we're certainly not rushing over to Western Australia. Again, we've said that we will work over in Western Australia for the right clients on the right contracts, but we're certainly not looking at rushing over there and putting a flag in the ground. Again, we've got some wonderful clients that work all over the world. If a good opportunity came up with one of those clients in a foreign jurisdiction, you know, multi-rig, multi-year contract that hits the right numbers, we'd always look at it. We'd absolutely hang on to the coattails of those global major miners and go with them on their journey wherever it may be. Again, we're not actively rushing off anywhere in the near term as such, but certainly if something came up, again, as Nathan said, we'd always look at it.

Another one from Daniel. With the business now in a scale position backed by a large high quality customers, what sort of through the cycle of debt levels do you think is appropriate going forwards?

We've said 15 is the number. Again, one of those pillars is debt. We may bring that down. If we're not happy with the additional growth in the market. So again, I think ideally lower the debt is better. just where things are softening. But we can turn that dial pretty quickly up and down depending on, again, as Andrew just said, if we had a major that wanted a number of rigs, then we'd have to dial that debt back up as long as those hurdles are reached or we'd dial it back down depending upon where the market's sitting and if we're comfortable where we are and we've reduced that debt even further. But at this stage, we've made the decision that we'll keep it around $15,000 But again, we're actively looking at it on a monthly board meeting.

Another question from Tom. Where do you think we are in the rate cycle? Are customers comfortable with your long-term margin targets closer to 20%?

Yeah, I don't think the customers are comfortable with us making a great deal of money at the best of times, so They love seeing us do a great job and be safe and all those sort of things and bring innovation to the table. But as long as we're just sort of getting by. But look, we have got some fantastic customers and obviously inflation ran away pretty quick, pretty hard. And as Greg said in his presentation, we've reset the contract book now. We've maybe got, I think, maybe one to go. But all the contracts and the prices and everything have been reset and we're sort of back to a business as usual sort of position now. I think getting rates, rate increases above inflation from this point moving forward will be tough, Nathan. Yeah. So you're sort of probably limited to inflationary increases from here or sector calculated indices and things like that from here. But certainly, we always say our target is a 20% EBITDA and then it flows down to a good level of NPAT and with some of the benefits below the line that Greg spoke about too. But certainly if we're up near that number, I still think it's a good number. So obviously people can see where we came out for the first half. We'd like to equal that or do a bit better in the second half if we can. But again, as a team, it's always something that we're focused on and trying to improve and do better.

Thanks, Andrew.

A quick one from me, if that's all right. Just looking at, obviously, the revenue being fairly constant from H1, 23, and then you give the comments that you had with weather in the previous series, and obviously balanced by some of the underground reutilisation, obviously tapering off, but then obviously up by 20%, 21%. Is that a function more of sort of having that surface fleet on standby versus active rates, which are a higher margin, and then somewhat moderated by just not having that utilization of those underground rigs? I'm just trying to understand. This is obviously a much better margin if you've got the rigs turning as opposed to sitting around doing nothing in one of the scenarios in the previous half. Just the balance of those competing elements to end up with flat revenue versus 21% increased EBITDA.

Yeah, I think that's fair enough. We've always said there is a level of protection in the contract for wet weather so you're not going to lose money necessarily. to charge a standby rate of sorts, but obviously you do lose your margin. So I think your analysis is spot on. You know, weather impacted previous half. Those rigs by definition still earned a revenue, just a lower one. And that's really just enough to cover costs. Whereas in a scenario where it's the opposite, revenues earned at a higher margin. And I suppose, again, just a mix in the, or shift in the mix of revenue as well is probably driven the fact that the revenue sort of appears flat but the margin's up. It probably talks to the shift in the mix as well. But definitely your points around the wet weather and the standby and the margin dilution are spot on.

Yeah.

And again, it's always difficult to sit here and pick it apart. You know, there's surface rigs and underground rigs, and as Greg says, the mix has sort of moved from 50 surface, 50 underground to 55 surface, 45 underground. The surface rigs are bigger, they're more expensive, they've got a higher capital cost. They invoice more per shift. And so, as Greg says, when he talks about that mix, it's a case of less underground rigs working that work a lot of shifts at a lower revenue and probably margin number. you know, with a higher proportion of surface income, less rigs, less shifts, higher income per shift. So, you know, that will move around a little bit based on what's happening in the particular quarter or half.

Thank you. Thank you. Another question from Tom. You referenced some easing inflationary pressure. Do you think the labour and the shools cost can ease from current run rates?

No, I don't think so. You know, unfortunately in the labour now we've got the new IR rules. That's going to add cost to labour every time a contract finishes now. So I think that's just right across the board of Australia, not just our business. So whilst I don't think labour wages as in demand for higher wages will be there there's going to be government costs that now weren't there before that are now there consumables potentially um again if demand drops prices will drop the juniors aren't buying the consumables um obviously potentially that might come down but i would more more than guess that they'll just stay constant thanks

I think the next one's for you as well, Nathan, from Steven. I'm sure you can see, I mean, the last call, you spoke about the business having a data coming in at around 50 mil, with a possibility of 55 or more in a supportive environment.

I think the question was asked to us back then was, you know, what is a company capable of doing if it's running, you know, full throttle, four rigs operating, you know, based on that, the rig has the capability, the business has the capability of doing 50 to 55 based on that. And you can escalate that out based on 70 odd rigs running versus 90 odd rigs running. And so I think, yeah, it's capable of doing that in the right circumstances, you know, and in the right market. But we're starting to see, you know, the mind of the juniors softening. So, you know, If we get them all working, I think we could with the rates that we've now got and the reset of the numbers that we've got. That's still a doable number in the right circumstances.

And I think just further to that, that last quarter that we had in FY23 shows it can be done. But as Nathan said, you need everything going and everything in your favour. It's certainly got the ability to do it. You just need everything going and everything in your favour. And again, as Nathan says, we're patient too. We're not just going to put idle rigs out for the sake of putting idle rigs out and making a poor margin. And then all you've got to do is have a capex to rebuild those rigs. We'd rather leave the rigs parked up, wait for the right client, the right job, the right opportunity, and then make a good return. So just, again, that patience will... will always hold us in good stead. So, you know, we had a great Q4 last year. I mean, they're not always all going to be like that, as we've seen, but certainly, you know, if you've got everything in your favour, the fleet we've got, you know, it can be achieved.

Thanks, Andrew. Thanks, Nathan. That's the last of the questions so far. If there's any more, just quickly type in. Otherwise, we'll leave it at that. One last one from Jason. With the tax losses on the book, why should it remain for the next financial year or two? Why is emphasis on capital returns greater than dividends instead of the value of creative buyback at this current share price?

I think it was really about following through on what we said. I certainly like buybacks for the longer holding shareholders. But fundamentally, we as a board decided that we will go ahead and do the full 75%. We wanted to show our shareholders in the market that we can deliver on that. So again, the previous question, whilst we'd all like to be able to get to $50 million EBITDA, our position is to run a good business and return dividends and show that this is a genuine business that can actually deliver that on what we say it can. We could change that next year and we'll see how that runs. But yeah, I agree. There's certainly, again, different pillars that we can pull. This year was about delivering on what we said we were going to do, and that's what we've done.

Thanks, Nathan. Okay, that was the last. Guys, again, well done. Thanks for your time today. For the audience, this, again, is recorded, and I'll circulate it once it's ready. So Nathan, Andrew, Greg, thanks for your time today.

Thanks, everyone. Thanks, everyone.

See you. Bye.