Capital Limited in name only

But there’s a lot more to the business than first appearances – a point you might think investors had grasped, more than a decade on from the company’s London initial public offering and seven years into a 330 per cent share price rally. Indeed, by any measure, Capital has talked and walked like a well-managed growth company for some time, and little suggests that its trajectory is about to stop.

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How then, does one account for the cheapness of its shares? Despite a lack of debt, they trade in line with book value. And despite rising sales and an expanding operating margin, they trade at less than six times forward earnings, a 40 per cent discount to peers and the stock’s own five-year average of nine. Capital’s price-to-earnings growth (PEG) ratio of less than one also suggests the past year’s share price appreciation has been overly cautious. Not that long-term investors will have minded; had they reinvested their steadily growing dividends back into the stock, annual returns would have averaged 25 per cent since late 2017.

The answer, we would venture, is that the market has mispriced Capital’s risk premium.

Let’s start with the basic mechanics of the business. Capital provides a wide range of services across the mining cycle, from the exploration phase to a mine’s development and eventual production stages. These include the leasing of equipment, geological sampling, fleet management, and drilling and earth-moving work. Since 2019, it has offered on-site laboratory services, which allow its clients to outsource geochemical analysis and assay work to an independent, licensed contractor.

These services are provided through contracts comprising a mix of management, volume-based and per-sample fees, and are typically signed for between two and five years. But Capital’s close working relationships with its mining customers mean the group always has a clear idea of long-term spending plans, and repeat awards are common. Contracts also contain provisions that help to shield Capital from the effects of cost inflation.

One historic issue with mining services business is the limited demand visibility. This matters a great deal to services businesses’ own capital-intensive investment decisions: time the cycle wrong, and profits and cash flows can quickly sour. However, Capital is addressing this in two ways.

First, since 2019, a rich source of new contracts has come from the company’s own portfolio investments. By taking equity stakes in miners, primarily at the exploration and development stage, Capital has gained a strong idea of its pipeline and the likely timing of tendering activity, which the company says is always carried out at arm’s length.

The return on this investment strategy has been excellent. Since Capital began taking stakes in 2018, annual recurring revenues from portfolio firms has jumped from zero to $48mn (£40mn), while the value of its listed and unlisted portfolio has swelled to $47.3mn, from a cumulative cash outlay of $11.5mn. Granted, these stakes are highly speculative and prone to skew the group’s reported income statement, but the dual benefits of these investments are plain to see.

Second, the group recently appointed resources and logistics veteran Peter Stokes as chief executive. He is based out of Perth, which will not only puts the company close to the capital spending decisions of important prospective future clients, but frees up co-founder and executive chairman Jamie Boyton to look for more contract opportunities around the world.

Currently, the clear majority of mine-site sales are made in Africa, where Capital is the largest independent mining services company and focuses largely on tier-one assets managed by premier mining groups including AngloGold Ashanti (US:AU), Centamin (CEY) and Barrick (US:GOLD).

Although there is competition in many of the countries where the group operates, international miners’ preference is to partner with established names with a good track record of safety and local workers. On both these fronts, Capital is a sector leader. The group is also bullish on the outlook for mining capital expenditure, citing the historic depletion of reserves across various metals and massive forecast demand for materials that will be critical to the global energy transition.

Recent contract awards – and rising utilisation rates for Capital’s growing fleet of drilling rigs – suggest this demand is already on the up.

Arguably, the customer base is more concentrated than is ideal, with around half of all revenues coming from the Centamin-operated Sukari mine and another unnamed project. However, these revenues are split across six on-site contracts, so are not as risky as they appear.

More broadly, by selling ancillary services to a hot sector – and having built up a good track record and scale since it began trading in 2005 – Capital Limited is a stock in the best tradition of ‘picks and shovels’ investment plays. Even without growing organic sales from its dominant drilling business, its canny push into laboratory services looks like a strong driver of growth and is expected to generate more than $80mn in annual revenue by 2025, up from $30mn this year and just $3mn in 2019.

The volatility of the mining cycle means investors should be careful not to forecast too far ahead. But the strength of Capital’s near-term outlook could hardly be more detached from its market valuation.