Mincon: Acceptable 2018 Results Show 10% Organic Growth And Outline ‘Disruptive’ New Drilling Product

2 thoughts on “Mincon: Acceptable 2018 Results Show 10% Organic Growth And Outline ‘Disruptive’ New Drilling Product”

1. Mincon (MCON)



   Publication of 2018 annual report

   MCON’s annual reports provide a very different management narrative to that published within the preliminary results RNSs.

   Although parts of the chief exec’s RNS commentary are contained in the annual report, many parts are completely re-written and some parts are dropped entirely. For instance, the outlook section given in the 2018 results RNS was not reproduced within this annual report.

   Nonetheless, the management text within this annual report read very well. Management appears to be concentrating on developing better products, creating a wider competitive advantage and running the business with a long-term mindset.

   Here are the snippets of interest:

   1) Chairman’s and chief exec’s statements

   The key points:

   

* Improving the group’s financial returns (my bold):


   “It is good that we have continued to build profitability, now we will focus on increasing the return on capital employed, on the cash growth and on the efficiency of our manufacturing and distribution base. These are among the objectives the Board has set for the Executive in 2019.”
   …
   “The Executive has installed the additional factory capacity as planned, and the factories are meeting the order books without undue delays. We are now seeking increases in efficiency, savings in overhead spend, increased return on our investment, in our sales expenditure, and in cash allocation to prioritise the reward for all our stakeholders.”
   …
   
“Over the last few years we have doubled our size and more, but there is no gain in this if the earnings don’t follow. While we now have a stronger market position and offer a wider range of excellent products, this market position must translate into better profitability and a better return on this investment.”
   …
   “We are embracing a regime of continuous development, of continuous improvement in the service delivery, and new ways to enable our customers to achieve the same objectives as we seek ourselves; capital efficiency, better safety, improved environmental protection, higher return on capital employed and better cash flow for investment and for stakeholders.”

   * developing a competitive advantage — product design and customer service (my bold):

   “The Group’s overall strategic objective is to develop long term sustainable competitive advantage with our products and services for customers, for the benefit of our shareholders and all stakeholders.”
   …
   “We are committed to:
   *better engineering

   *the creation of intellectual property at the core of our products, supporter inter alia by patents

   *better service delivery,
   
*and improving the skill sets of our teams”
   …
   “We put engineering at the core of what we do, and high quality products and customer service at the centre of our offering. It is our belief that the building up of our intellectual property, the increased quality of our manufacturing, and the investment in our service is a combination that protects and develops our products, our people and our margins.”
   …
   “Our out-sourcing, and third party manufacturing is minimal. This gives us substantial control over the quality of what we manufacture but more importantly it means that the compound intellectual property of our products resides in-house. This has been key in the development of the next generation of products outlined below.”
   …
   “If we do not work to make our current range of products redundant by developing new, better products, we can rely on our competitors to do this. If we don’t renew our channels to market, and play our part in accepting the way our customers wish to develop their requirements then we will be superseded. If we copy what the market structure already is, we will fail, as we will have embraced the existing structures without the market advantages of the leaders. Not only do we have to continue to develop our own range of current products, but we have to plot their replacement by newer technologies and newer delivery systems.”
   …
   “We have found that the intellectual property of our business is as much in the service of our customer at the mine or construction site, as it is in the performance of our product designs, or the quality of our manufacturing processes.”
   …
   “We are working to find a balance, and we are prepared to take a longer view of our business rather than chase growth for the sake of growth.”
   …
   “As owners we believe that long-term sustainability will remain a key priority for Mincon’s business, and consequently our engineering efforts and global growth. Mincon is building a business for the future by recruiting and nurturing new engineering talent; developing its existing service and manufacturing centres; diversifying its product range; and expanding market presence.”
   …
   “Mincon has had a clear vision and determined focus giving priority towards:

   * Highest design specifications

   * Best manufacturing methods and processes
   
* Delivery of superior products to our customers”
   …
   (I like the quote “If we do not work to make our current range of products redundant by developing new, better products, we can rely on our competitors to do this”. Seems as if management has the required paranoia to avoid complacency).

   * Products, product range and becoming a challenger brand (my bold):

   “Mincon’s primary engineering objective is to design and manufacture class-leading and highly efficient drilling consumable tools that use less energy per metre of drilling. Rock drilling is an energy-intensive undertaking, with efficiency being measured in the speed of drilling; the life of consumables; and the reliability of equipment.”
   …
   “In building up the Group in recent years, and in assembling the drill string offering, the team in the Mincon Group has concluded that there is a world of difference between offering the products in a catalogue, even an on-line catalogue, and engaging directly with the end customers on their specific requirements to achieve their objectives.”

   
…
   “We have assembled and now present the entire drill string as a sales offering, with a range of sizes and product types that address a wider range of markets, directed at the surface drilling customer. With a full range of drilling consumables we can meet the requirements of our larger customers, and through joint partnerships with these end users, savings will accrue on both sides. This positions us as a challenger brand in the mid-market, and away from the more commoditised low end business.”
   …
   “Our business has to play its part in being environmentally aware, in minimising the energy that the products use, in reducing ground disturbance in sensitive and high population density sites, and in matching our customers ambition for efficiency. We see this as a challenge to be met, not a burden to be endured, and it is this opportunity to rethink and renew the industries that we serve that characterises the challenger mentality we are adopting.”

   2) Competition

   Mincon helpfully named its main competitors (my bold):

   “The markets for the Group’s products are highly competitive in terms of pricing, product design, service and quality, the timing and development and introduction of new products, customer services and terms of financing. The Group faces intense competition from significant competitors and to a lesser extent small regional companies.”

   “The Group’s principle competitors are Epiroc which is headquartered in Stockholm, Sweden with a global reach spanning more than 170 countries and Sandvik which is also headquartered in Stockholm, Sweden with business activities in more than 130 countries.”

   3) Customer concentration

   

The report suggested Mincon is not dependent on a handful of clients:

   “During 2018, the Group’s top ten customers have accounted for approximately 21% of its revenues.”

   The 2017 report said the group’s top ten customers had accounted for approximately 24% of group revenue over the past three years.

   4) Risks

   The report included a new Brexit risk:

   

“Implications in relation to Brexit
   The Group has a carbide manufacturing facility in the UK, along with a sales and distribution centre selling all our major manufacturing components and some third party product. The Group envisages minimal impact from Brexit in the coming year. The Group’s revenue that was generated in the UK during 2018 was €3.3 million.”

   5) Driconeq

   Confirmation that the integration of Driconeq was indeed not straightforward (my bold):

   “Driconeq was a difficult acquisition, geographically spread, marginally profitable, with a subsidiary in administration, and it consequently required very significant senior management time, but it has bedded in well and we believe that it meet all our expectations for it.”

   6) Mincon Nordic



   Parts of the group are not profitable and have scope to improve the group’s total margin (my bold):

   “Our Mincon Nordic business grew very significantly in 2018, and while still marginally loss making, it is becoming a formidable competitor in that market. The competitive response in the region has been robust, if uncommercial, but it is breaking their business and will prove to be short term. We will continue to build our sales in the region as we are in this market for the long term, and may continue to make investments in the territory.”

   The 2017 annual report (point 2) indicated Mincon Nordic had the objective of breaking even during 2018.

   7) Cash flow

   Confirmation that the significant 2018 cash investment in working capital and capital expenditure is not expected to be repeated for 2019 (my bold):

   “The capital investment and inventory investment took a heavy toll of our cash flow in 2018, with the improved cash inflow being met by a significant inventory increase and capital expenditure build out. However we have passed peak investment and expenditure related to these categories and through 2019 should see the outflows reverse.”

   In fact, capex could reduce to below the depreciation charge during the next three years (my bold):

   “Capital expenditure is expected to run at or below depreciation in the coming three year cycle unless we see the type of growth that we achieved in the last three years or unless we decide building a new factory makes sense. We will flag that some months in advance if we do, otherwise the plan for 2019 is to return to cash generation as we stabilise our growth.”

   8) Review phase

   The results RNS mentioned the business pausing for breath following a few years of rapid growth. The following text suggests the acquisitions made since the flotation may have brought with them products that are not as lucrative as others within the group:

   “At the same time we will review our product portfolio and decide on the basis of margins and scale, which products, customers and markets are worth the investment and risk, and which are not. We are fully in favour of growth, but we feel it should be deliberate, commercial and valuable to the Group.”

   9) Corporate governance

   New AIM rules introduced last year have prompted MCON to include a new corporate governance section.

   Most of the text is very ‘boilerplate’ but two items stood out (my bold):

   “The Mincon Group plc has decided to deliver considerable detail on the operations and trading on a quarterly basis to the shareholders and market, beyond what is required just for compliance, and at a level of detail committed to providing insight on the thinking, the strategy, and the allocation of the assets and people. In addition to this, shareholders are actively encouraged to visit key sites, meet key people and discuss the business of the Group.”

   MCON’s quarterly updates are commendable, but could lead to short-term decision making (by investors and management).

   Having the chief exec know all about the products is encouraging (my bold):

   “The current CEO is the chief engineer and is the principal designer of the current range of products.”

   That said, being chief exec and “principal designer” could be too much for one person.

   Within the chief exec’s statement, the chief exec wrote: (my bold):



   “Our primary engineering objective will be driven by our engineering leadership, the Technology Steering Group. This group of five is led by myself (chief executive Joseph Purcell) and is made up of senior engineers who each have many decades of experience in the rock drilling industry. The experience in the group is very broad and includes the areas of mechanical design and simulation; metallurgy and heat treatment; market and application knowledge; and hands-on drilling. The function of the group is to develop the next generation of engineering leaders and to liaise with all levels of the Mincon Group, including the customer service centres, so that it can analyse customer feedback, and prioritise areas for technology development.”

   The ‘principal designer’ of future products may well be one of the “next generation engineering leaders”.

   10) Director pay

   The chief exec’s basic pay gained 12% — perhaps not surprising given underlying operating profit advanced 16%. €300k is equivalent to £261k and does not seem outlandish given the profitability of the business:

   

   The sales director’s pay is denominated in USD and I suspect his 22% EUR pay rise is due mostly to currency fluctuations. His basic pay fell from €207k for 2016 to €201k for 2017.

   The executives have commendably not collected any bonuses since the 2013 flotation. I do get the impression the executives — with a 56% combined family shareholding — are aligned to ordinary shareholders.

   11) New accounting standards

   No major impact from the new IFRSs:

   

   

The effect from IFRS 16 Leases is small:

   

   12) Employees

   I am sure the Driconeq acquisition has dampened my employee ratios:

   

   Revenue per employee dropped from €300k to €229k, which is still reasonable but is the lowest since my records start at 2010 (prior lowest was €256k during 2016).



   The average employee cost €64k, down from €73k during 2017 and in line with the €64k seen during 2015 and 2016.

   Employee costs as a proportion of revenue advanced from 24.2% to 28.1% during 2018 — the proportion is now the highest since 2010 (previous high was 25.2% during 2016).

   No wonder revenue per head was not mentioned in this annual report (the ratio was mentioned in the 2017 edition (point 2)).

   13) Inventory

   As mentioned in the Blog post above, year-end stock levels represented a huge 42% of revenue:

   

   MCON aims to reduce the level for 2019.

   

14) Trade receivables

   Year-end trade receivables encouragingly represented 18% of revenue — matching the level for 2017 and the lowest since 2013 (16%).

   

   70% of trade receivables were less than 60 days old — in line with 65%-76% range seen during the last five years.

   I suppose within its forthcoming efficiency drive, MCON could do with asking customers to pay a little quicker.

   15) Land and buildings

   Part of the sizeable capex spend was on land and buildings:

   

   Of the €27m capex spent between 2014 and 2018, €8m has been on land and buildings. Total depreciation during the same time was €14m — so not entirely covering the €19m capex spent on plant, equipment etc.

   16) Share options

   Options represent a modest 1.1% of the share count:

   

   Maynard

2. Mincon (MCON)

   Q1 Trading Update published 25 April 2019

   Nothing too surprising was revealed within this rather long-winded update following the 2018 results RNS and the extra management narrative within annual report. My comments are interspersed within the full text:

   ———————————————————————————————————


   Key elements (comparison of Q1, 2019 to Q1, 2018):

   Continued improvement in our product sales mix:

   · Mincon manufactured product sales up 30%

   · Being organic growth of c. 4% and

   · Acquisition growth of 26%

   · Third party product sales down 5%

   Resulting in:

   · Revenue up 24% overall

   · Profitability slightly behind last year in Q1

   We continue our strategy of improving our product mix by manufacturing what we sell, where this provides commercial advantage. This has resulted in Mincon product representing 86% of sales in the quarter compared to 81% last year and in the period under review our manufacturing capability has now built to a level where we are able to meet customer orders in a normal commercial timeframe. This allows us to focus on the efficiency of delivery and margins, and to reduce the extra overhead that had come into place to meet the last phase of growth, before we meet the service requirements of the new direct sales coming on stream through the rest of the year.
   ———————————————————————————————————

   This follows MCON’s plan for a ‘year of consolidation’ — organic sales up 4% does not sound great but is positive at least.

   Profitability “slightly behind” may be due to the upfront costs of becoming a ‘challenger’ brand (see below).

   ———————————————————————————————————
   Revenue
   In the quarter the Group caught up with the order book, is current with its orders, and has additional capacity available in the production facilities of certainly 10% to 20% even at the new levels of throughput.

   The heat treatment facilities are now coming on stream in Benton, Illinois this month after a successful series of commissioning throughput, and are expected to come on-line in Perth, Australia in June/July this year. The additional vacuum furnace capacity has been commissioned in the Marshalls Carbide plant, and the final furnace arrives in Shannon in July. These capital commitments extend back several years in some cases, and in the last year new plant and equipment capital commitments are running well below the depreciation run rate of c. €4m a year.

   Factories are, in the main, well specified now for the product range and sales level. In the first quarter we continued to reduce our inventory of rigs, with the later ones getting sold at cost less commission and a degree of refurbishment, certainly above the written down value they were held in prior to the year end. We had eleven rigs, and we have sold six in the last few months. This was an important objective, and to some degree it suggests we are reasonably well into the mining recovery flagged two years ago.
   ———————————————————————————————————

   Good to hear:

   * capacity can handle another 10%-plus production increase
   * capex commitments running below depreciation after some years of at higher levels, and
   
* those difficult-to-shift rigs are being sold above book.


   ———————————————————————————————————
   The Challenger brand
   We found, as we completed our drill string build out, and extended our ranges of hammers and bits, that we began to be able to compete in supplying complete drill consumable solutions directly to mines. As we build out our revenue in construction piling, we find that the natural shape of the business is higher value contracts extending over a number of years. The investment in our engineers and engineering, together with the experience of drilling held by key service team members, means we can advise on the consumables solutions for the end customers.

   This is a relatively new business structure for us, but it both fits with the ambition to build out relationships with the end-customers, and with the engineering philosophy in the Group. We have to offer better value, whether it is the service commitment, the engineering, the pricing or, as we find, a combination of all three. Dealing directly with the end customers allows us to create the breadth in relationship that positions the Group as a reliable element of the construction or mining process.

   We have to be reliable. So much of what we do is at the start of the processes, whether it is delivering the ore tonnage, or the piling that supports buildings and harbours, that the fault tolerance of the end customers is low, and the potential liabilities higher than simply replacing a hammer or a bit. We are getting much deeper into the service element. This dependence by customers on our service and engineering means that we also have to keep the requisite inventory near the contract site, and service individuals proximate to the service delivery. This is an emerging model for us, and each contract requires people, investment, service-guarantees and time.

   We have recently won multi-million dollar business in Chesapeake Virginia, in Indonesia, in Chile, and in Finland which are not reflected in this growth as yet to any degree. These will require some restructuring and build out in the Group to support the end customers, incur some initiation and front-end costs, and this is causing a rethink of our management structure to lean towards a regional footprint, mapping the thinking behind the investment in the key factories in the Americas, Australasia/Asia Pacific (APAC) and EMEA (Europe Middle East Africa)
   ———————————————————————————————————

   The ‘challenger brand’ approach — which seems a very credible long-term plan — would appear to require upfront costs, which might help explain the lower Q1 profitability.

   ———————————————————————————————————
   Gross margin
   Gross margin was at about the budgeted level considering the expected product mix changes, at 35%, as this includes a full quarter of the lower margin Driconeq Group in Q1, 2019, and nothing from this acquisition in the previous year. The drill pipe business (excluding their profitable heat treatment activity) has a gross margin of c. 20%, and the turnover is about a sixth of our revenue. It’s a good acquisition and a good team, and there is additional margin to play for in the supply costs side of the business in phase 2 of the on-boarding. Overall in the Group we can comfortably produce what we couldn’t deliver a year ago, and our eyes are inward now on overhead reduction, factory efficiency, and the realisation of assets and disposal of businesses that don’t sit with the current three year plan.
   ———————————————————————————————————

   “Phase 2 of the on-boarding” reads as if the Driconeq integration has not yet been entirely completed.

   A 20% gross margin from 1/6th of revenue is useful to know for future results comparisons.

   ———————————————————————————————————
   Group review and streamlining
   We have developed a complex business model over the last few years as we added factories, customer service centres and products, organically and through acquisition.

   We have decided to overhaul the Group, reduce the overhead by a targeted €3 million a year, and reorganize on a regional basis into three zones; Americas, EMEA, and Australasia/Asia Pacific. This will cost some money, take some time, but we have already reduced overhead by a run rate of €1 million a year since the recent budgeting and review planning. It is our expectation that the reduction in expenses will become self-financing in the current year and provide the service level and response needed to support the positioning of the Group and the brand as a challenger to the incumbent market structure.

   Initially this will not substantially disrupt the Group, but develop the reporting structure, and increasingly as the other Group reviews take place from the operational side, we will be making decisions through 2019 on what we make and where we make it. We have flagged this before. Since we expect low margin, less engineered products to come increasingly under pressure in an interconnected world, Mincon Group is repositioning with the full consumables offering and a higher service element, directly to the larger end customers. We aim to combine this with product systems that are more fuel efficient, offer better value in use overall and are more environmentally friendly.
   ———————————————————————————————————

   Savings of €3m per annum are significant when 2018 operating profit was €16m. The text confirmed the annual report narrative that certain less-profitable products may be sidelined.

   ———————————————————————————————————
   The Greenhammer hydraulic systems
   We expected the system to go back into the beta testing on site in Australia in March, but the mine was evacuated for the first time in nine years as cyclone Veronica blew through Western Australia. In consequence the mine suffered flooding and the production schedules were severely disrupted. The rigs had to go back into full production to catch up on the ore shortfall , and we now expect to be back on site in May. We have spent the time improving the system in accordance with our own testing and constant development, and we are ready to re-engage the system when the rig comes off-line.

   The smaller size system is also available, and we continue to develop the thinking and engineering around different applications and hammer types to continue to increase the addressable market for the system suites.
   ———————————————————————————————————

   No further developments.

   ———————————————————————————————————
   Market comment
   We have seen the quarter deliver increased revenue with only moderate profit movement, and the growth is mostly from the addition of a distributor, and the additional quarter of the Driconeq Group, both lower margin activities. We have seen the full quarter impact of the overhead build out while the business growth in the direct model will be realised through the coming months and years.

   Our manufacturing and delivery, which has been an issue for the last two years, has caught up with our sales growth, and now that we can deliver in accordance with the customer requirements, we can focus on the efficiency of our factories and the value from our customer centres. Other than that, we have to take each new direct customer opportunity as a separate project, and make sure that we engage cross-functionally to meet the service requirements while earning a return commensurate with the investment and risks.
   ———————————————————————————————————

   Nothing was said about the wider demand for MCON’s products.

   As MCON has noted, the year ahead is one of consolidation and re-jigging the business structure to accommodate dealing direct with end-customers.

   The prospects for the rest of 2019 would therefore seem subdued.

   Maynard

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