Weir targets winning megatrends

The decision to focus Weir on mining was made shortly after the appointment of Jon Stanton as chief executive and John Heasley as finance director. The new management saw the group's minerals division as stronger than its oil business and with a better outlook despite the industry coming down hard from the highs of 2011-14.

Confidence in the growth potential of the mining technology operation has been underpinned by major long-term demographic trends, such as the growth of the middle class, especially in Asia, and urbanisation. The push towards electrification is also expected to support strong demand for copper for many years to come. Meanwhile, the inherent strength of Weir's minerals business and its technology was illustrated by the fact that margins stayed up even while industry spending tailed off. Management believes the division's operating margins through a typical cycle should range between 17 per cent and 20 per cent.

The company’s business model is to sell hugely expensive bits of kit to a miner, for tens of millions of pounds, and then service that machinery for the next 20 years-plus. Around 80 per cent of mining turnover comes from aftermarket sales and servicing, and these recurring revenues have achieved a compound annual growth rate of 9 per cent since 2009.

A major step in making Weir a mining-only company came in 2018, when the sale of the flow control division was announced. This has now been followed by US giant Caterpillar agreeing to pay $405m for the oil and gas division. 

Unfortunately, the lag between the decision in 2016 to focus on mining and getting shot of non-core divisions meant the largely North American onshore-focused oil and gas services and equipment business went through its own downturn. This resulted in a £546m impairment in 2019 after orders and revenue plunged 30 and 25 per cent, respectively. Some solace can be taken from the fact that by 2019 sales from the group's minerals division accounted for 56 per cent of the total, with oil and gas just 23 per cent. The two divisions had been close to being equal contributors in 2014, when the split was 46 per cent to 41 per cent.

Happy new Weir!

So what will the mining-only Weir look like? The refocusing of Weir's business on mining has been about acquisitions as well as disposals. In 2018 it bought ESCO, a company that provides parts to mine machinery, for $1.3bn. This will make up one of the refocused group's two divisions, the other being the aforementioned minerals business. ESCO added sales of £572m and an operating profit of £83m in 2019. Meanwhile, under Weir's ownership, it has seen operating margins rise from 11.1 per cent to 16.1 per cent, with a target of 17 per cent. 

ESCO's contribution in 2019 compares with an operating profit from oil and gas of £37m, which was down from £96m the year before. The mineral division, meanwhile, continued to achieve impressive growth, with the operating profit of £270m up from £250m in 2018 and £228m the year before that.

Despite the strength in mining, Weir’s overall operating profit margin has come down from 14.9 per cent in 2017 to 13.2 per cent last year, as the oil and gas divisions margin crashed to 6 per cent. It is clear Weir is stripping out a weak division. But avoiding the negative outlook for hydrocarbons is not the whole story.

The Covid-19 recovery has revved up demand for metals, with government stimulus in China and beyond spurring big price rises in iron ore and copper. These often run in different directions to gold, which people move to in times of uncertainty. The 2020 effect sees all three metals climb at the same time, which can be explained by the unique mix of economic strength and weakness shown in global equities and GDP numbers, respectively. 

Beyond the Covid-19 recovery, there is a broader concern about current copper and gold reserves, which are down as a result of exploration dropping in recent years. The excitement over projects like Kamoa-Kakula – a major copper find 40 per cent-owned by Ivanhoe Mines (Can:IVN) – shows the industry is desperate for high-quality deposits, while at the same time Robert Friedland, a legendary miner who is developing the project, chose to sell part of it off to the Chinese company Zijin Mining to finance development. 

But without too many more Kamoas on the horizon, it’s clear smarter mining techniques are also needed to get more out of existing sites. On top of that requirement, largescale mines today use far too much power and water, and workers are still killed on sites all over the world. Any company offering improvements in these areas is worth looking at. 

The combination of reserves falling and the introduction of emissions and environmental goals looks very positive for Weir. “As ore grades decline, you have to process more ore to get the desired outcome and that means more wear on our equipment, which drives demand,” says Weir's Mr Heasley. “Standing back and looking longer-term though, as our customers, the miners, are looking to extract more copper, they themselves are trying to do that in a more energy-efficient way.” 

A "landmark" iron ore deal is a good recent example of this. Weir signed a £100m agreement with Fortescue Mining Group (Au:FMG) last year to provide a high pressure system for the mill (that grinds up the ore), which saves 30 per cent in energy use and cuts tailings waste. 

This seems like a fairly standard pitch on cost-saving grounds – we’ll save you energy, give us the contract – but that 30 per cent saving will also result in hundreds of millions of tonnes of carbon dioxide not being released over the decades-long life of the Iron Bridge mine in Western Australia. FMG gets a boost towards its net zero operational emissions target for 2040 and Weir gets its largest single mining deal, which will generate revenue for years. 

This is one example, but the industry is extremely focused on cutting its impact, anxious to keep green-minded institutions onside and wary of future regulatory risks. 

Greener, not green

The company is not turning itself squeaky green with its oil and gas sale, however. The mining division is also a supplier to oil sands and coal operations, which collectively provided 20 per cent of revenue last year. 

The company largely supplies metallurgical coal mines, used for steelmaking, while its exposure to thermal coal has fallen. The oil sands contracts in Canada will seemingly be around for longer, according to the finance chief. “[Oil sands projects] have proved resilient,” he said. “It's not going to be a significant growth driver over the coming years, but those are longstanding, heavily invested projects, and they will continue to operate for the foreseeable future.” 

That spread across base metal, bulks and gold means Weir is not going to suffer because of prices falling in just one of its markets, but it is exposed to the industry. Right now, with iron ore and gold very high and copper’s energy transition-demand case popular with buyers, it seems to be exposed to the right areas. The caveat is that prices are likely to fall at some point, given this is a cyclical industry, and orders will slow down in the short term. But the need to keep processing plants running means Weir’s clients will keep calling, even if it is to repair existing parts rather than to supply £100m in pumps to a new operation. Despite the more reliable income from repairs and parts sales, Weir also cut its final dividend from 2020 and has yet to bring the payout back. 

The other big caveat is that the oil and gas sale has not yet been completed. Any buyer sticking their hand up for a US onshore-focused business in late 2020 should know what they’re in for, but this is not yet a done deal. 

When the cash comes through, it will be used to cut debt. Net debt was an unwieldy 2.4 times Ebitda as of 30 June, but disposal proceeds brings that down to 1.9 times, and open up “organic or inorganic” expansion options. Forecasts of rising free cash flow will also help (see chart). On its prior record, we would imagine investment is done with an eye on the dividend coming back too.

By historical standards Weir's valuation is on the high side, but we feel the opportunity has fundamentally changed, with the company now offering the prospect of high-margin growth built on recurring revenues and three significant long-term trends: demographics, mining-emissions reductions and electrification. There is good potential for positive surprises from here.

Last IC View: Buy, 1,488p, 5 October 2020