Let’s get one thing out the way early on in this discussion: neither Bell Equipment nor Master Drilling has been a happy long-term hold.
Over 10 years, Master Drilling’s share price returned a compound annual growth rate (CAGR) of 5.7% and Bell has lost 24% overall, so even having a CAGR was a stretch too far for the latter. This excludes dividends in both cases, though buying cyclical companies for regular dividends is a misguided pursuit.
Interestingly, the divergence in share price between the two companies over a decade isn’t visible over five years, with close correlation during that period. In 2023 they tracked closely until March, when the release of results saw Bell pull ahead. Year-to-date performance at the time of writing is Bell +16.1% and Master Drilling -3.3%.
Armed with this information, investors might assume that Bell released much stronger 2022 results than Master Drilling. Both companies did well in 2022, with differences in the business models that need to be understood when looking at the numbers.
The underlying economic drivers of the businesses are similar, but certainly not the same. Master Drilling is a pure-play view on mining, with gold mining customers contributing 24% of revenue, silver, lead and zinc 22%, copper 20% and platinum group metals 18%. Bell is a significantly more diverse business, including exposure to infrastructure spend (not just mining) and the forestry industry.
The business models are very different. At Master Drilling, profits are driven by rig utilisation and pricing, with a fleet of rigs used around the world by mining houses investing in their operations. The word “investing” is key here, as Master Drilling doesn’t do well unless commodity pricing is supportive of an investment cycle in global mining activities. Bluntly, you won’t drill new holes unless you can make money from them.
Conversely, Bell manufactures and sells equipment. Though a strong commodity cycle is obviously supportive of the business, Bell can tap into maintenance capital expenditure at its clients, whereas Master Drilling is all about expansion capex. Additionally, Bell acts as a distributor for third-party products. This isn’t an insignificant part of the business, with third-party inventory levels at Bell similar to the value of manufactured goods at the end of 2022.
Both companies have healthy order books, but if Bell can have another solid year of demand, its investment in inventory will pay off
Through driving the utilisation rate and pricing per rental, Master Drilling can grow its revenue without necessarily building more rigs. Bell is on a treadmill, as big yellow machines need to be built and sold to generate revenue.
This subtle (but important) nuance is why the cash flow conversion profile looked so different at the two companies in 2022. Despite Bell reporting revenue growth of 28.2% and operating profit growth of 74.7%, cash from operations was slightly negative as the profits landed squarely in a higher inventory balance. Inventory increased 31% as the company responded to demand and prepared for the 2023 order pipeline. Debt at Bell also increased, with net debt to earnings before interest, tax, depreciation and amortisation (ebitda) of nearly 1.3, vs under 1.2 a year ago. Interest paid for the year was 42% higher.
At Master Drilling, about half of the ebitda generated in 2022 landed in cash generated from operations. Inventory increased by only 12.9%, despite revenue being up 31.7%. It’s not all good news though, as headline EPS increased by only 10.1%, well below the revenue growth rate, with a significant jump in employee costs at middle management level the primary culprit. Another important nuance is that Master Drilling reports in dollars, whereas Bell reports in rands.
So, we have two companies that tend to be lumped together by investors. With such close share price correlation over five years, who can blame them? The valuation isn’t that close though, with valuation platform TIKR showing Bell Equipment on an enterprise value/ebitda multiple of 5.8 and Master Drilling on 3.2. If we look at a p:e multiple using headline earnings, we find Bell on 3.75 and Master Drilling on 6. The local market loves p:e multiples, so the recent share price move is most likely attributed to closing the gap in relative p:e multiples rather than a look-through to cash flow generation and other metrics.
This cycle still has some way to go, with healthy order books at both companies. Momentum is with Bell as it emerges from a period of shareholder disputes, whereas Master Drilling has been an underwhelming favourite of small-cap punters for years.
Master Drilling has been a handy range trade for a while now, stuck between R13 and R14. At Bell, the trend has been up since the depths of the pandemic and the traded multiple remains modest.
I wouldn’t fight the market for now, despite the appeal of assuming that the Bell price will come back in line with Master Drilling. If Bell can have another solid year of demand, that investment in inventory will pay off. I would pick Bell here.
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