Note: I originally wrote this idea up in late November of 2014, at a time when BKN shares were trading at around ~A$3.60. Soon thereafter, on December 4th, Bradken received an unsolicited, non-binding takeover offer from a private equity consortium including Bain Capital for A$5.10. Most recently, on January 28th, 2015, the consortium pulled the deal, with the Bradken commenting that “…the recent volatility in global commodity and financing markets has impacted the consortium's ability to obtain financing on terms acceptable to the consortium.” The sudden announcement caused BKN shares to plummet, where they currently sit at A$2.73 as of 2/3/2015. Although one could read into the pulling of the private equity deal as a negative (perhaps they didn’t like what they saw during due-diligence), in my view it further validates the underlying investment thesis and has created a very attractive entry-point as the fleeing of merger-arbs has caused a dislocation in the share price.
·Bradken is a ~A$467mm market cap company that manufactures engineered products primarily for the mining and energy industries. For example, Bradken designs and manufactures the metal tracks that go on the bottom of mobile mining equipment; the steel teeth that line the buckets of bulldozers; and the steel liners of mineral processing equipment such as mills.
oWhile Bradken has enjoyed a good run for many years riding the Australian resource boom, investors have become spooked by the recent large declines in mining company capex, and have abandoned stocks that are perceived as being dependent on such capex, such as engineering firms and equipment manufacturers.
oThese concerns, together with recent declines in revenues and earnings, have caused Bradken’s stock to sell off, going from a high of $9.30/share in 2011 down to $6.00 in January of 2014, and now currently sitting at a multi-year low of $2.73.
oAs we will see, there are several reasons why Bradken has been excessively penalized by the market and is currently undervalued. In effect, the baby has been thrown out with the bathwater.
·Examples of Bradken products:
·The decline in capex by large mining companies such as BHP Billiton and Rio Tinto has been well publicized. The following slides, taken from recent investor presentations from these companies, summarize the issues:
·The important thing to note about these announcements is that they primarily refer to expansion capex. That is, the mining companies are still very much focused on preserving and increasing the production levels from their developed assets, as well as completing projects that are already far along in the construction process and close to being commissioned.
·Why is this relevant to Bradken? Unlike many other mining equipment companies, the core of Bradken’s business centers around consumable products that wear away and need to be continually replaced. For example, the steel teeth on the lip of a bulldozer bucket that actually makes contact with the minerals. The sales of these products are primarily tied to production levels and not overall mining capex. The following slide, from Bradken’s fiscal 2014 investor presentation, shows the portion of sales that are consumable products:
·To be sure, a portion of Bradken’s business (primarily sales to OEM equipment makers such as Caterpillar) has been seriously impacted by the slowdown in mining company capex. The point here is that this has already happened, and future reductions should be much more limited. As the company says in their investor presentation, they are now “well past the de-stocking and order cancellation stage in the last quarter of FY13 with improved order intake levels from that low point remaining stable throughout the year.”
oThe fact that the part of the business exposed to expansionary capex has already declined so much means that we are now primarily left with the defensible consumable piece, which should continue to perform well.
oThis core part of the business also has higher margins than the sales to the OEM mining equipment manufacturers (i.e., the part of the business reliant on mining company capex expansions) because Bradken is selling directly to the users of the products (i.e., the mining companies themselves).
·Despite the fact that most of Bradken’s sales are consumable products that must be continuously replaced as they are used up, the recent downturn in the mining sector (particularly among Australian coal producers, which have been seriously hurt by cheap North American coal imports) has been so acute in some areas that certain miners have been putting off replacing these parts in order to conserve cash. Ultimately, this is leading to pent-up demand, as these parts will eventually need to be replaced, as discussed in the following excerpts from Bradken’s 2014 earnings call: