Hughes Drilling on track for up to 71% profit increase 

(MENAFN - ProactiveInvestors - Australia) Hughes Drilling (ASX: HDX) expects to report a profit before tax of between A5 and 5.3 million for the six months to the end of December 2012 in guidance released today.

This marks a 61% to 71% increase over 2011 profits for the same period.

The continuing strong performance is driven by several factors including Hughes' operating in coal mines generally lower on the cost curve and the company's blast hole operations being a key part of an operating mine's production process.

Also, demand from Hughes' core blue chip client base continues to be robust and exceed the availability of quality equipment from highly productive service providers.

The company has not received any information from its blast hole clients indicating that the demand profile is likely to change in the short or medium term.

The high demand reflects expansion of existing operating "low on the cost curve" mines, displacement of low productivity competitors and new pits.

Another key factor positively impacting Hughes' strong growth is the company's blast hole service is not exploration drilling, nor are exploration rigs suitable for coal sector blast hole drilling.

Financial year 2013 earnings growth particularly reflects full year contributions from rigs that began operations part way through the 2012 financial year, new blast hole contracts beginning in the 2013 financial year " utilising new rigs, and growth of Express Hydraulics' agency and distribution activities.

With the growth of Hughes, its share of the Queensland and New South Wales markets, which produce 96% of Australia's coal exports, is now estimated at 37% of contractor and mine owner operated rigs and 46% of contractor owned rigs.

This market share reflects a large and growing market share in the Queensland market with strong growth opportunities off a lower base in the Hunter Valley.

Market share growth is driven by a combination of competitive pricing and consistently high productivity relative to Hughes' competitors.

Key factors include:

- Hughes' "fit for purpose approach": cost competitive with sustainable operating systems keeping costs down by doing all the essential and basic things properly;
- Sustainable operating systems comes down to operating one brand of blast hole rig, Reichdrill. A supplier responsive to Hughes and its clients design requirements;
- A single brand of rig simplifies inventory " control and quantities, simplifies, standardises and reduces cost of maintenance (all mechanics can work on any rig).
- Hughes rigidly enforces its maintenance programs (high reliability enhances high productivity and reduces cost).
- A stable workforce with a turnover of less than 10%.

Blue chip clients

Hughes Drilling has established itself as the leading blast hole drilling contractor in the Bowen Basin and the Australian open pit coal market, and is focused exclusively on in-pit coal production drilling " not exploration drilling.

This is a key differentiator as Hughes' business model is away from supplying blast holes services to the riskier coal exploration market.

Over 75% of revenue is associated with in-pit coal production drilling.

The company's client base includes blue chip clients such as Anglo American, BMA, Downer EDI, Jellinbah, Leighton, Peabody and Yancoal.

Customer sites are generally low-cost producers with substantial remaining mine lives, which is a key factor in the company's strong performance.

Hughes has the potential to further expand its contract position in the New South Wales coal fields.

As importantly, Hughes is working to grow its blast hole rig fleet to 38 to 40 rigs by June 2013, with the company only acquiring new rigs against secured and generally long term contracts in long life mines.

The company has a distribution agreement which provides exclusive access to Reichdrill blast hole rigs at a substantially lower cost than alternatives, with significantly shorter lead times.

Analysis

The current share price of Hughes affords investors an opportunity to invest in a significantly undervalued mining services company and acquire a portion of a business at a discount to its intrinsic underlying value.

This can be seen in Hughes expecting a substantial increase in profits for the six months to the end of December with profit before tax guidance of 5 to 5.3 million compared to the 3.1 million reported for the same period last year.

With the increase in profit guidance and a PE ratio of under 4, Hughes is undervalued compared to other companies on a PE ratio basis. We can see significant upside in valuation of company over the next 12 to 18 months.

Further underlying this valuation, Hughes holds deferred tax assets of A2.8 million and cash of A1.6 million as of 30 June 2012.