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  A disciplined driller for a disastrous market

BENJ GALLANDER, BEN STADELMANN, and PHILIP MACKELLAR

Sunday January 24, 2016

Major Drilling Group International Inc. fell 22.8 percent in 2015, and like just about anything that has anything to do with commodities, the stock has had a rough start to 2016. While oil's rout is dominating headlines, many forget that the commodities downturn actually started back in 2012 when gold broke into a new trading pattern. Since then, one commodity after another has gradually joined the current bear cycle.

Major Drilling's management adapted to the tough environment by acquiring Taurus Drilling. This helped them become less reliant on specialized and exploratory activity by expanding reach in conventional and underground drilling. Despite the shift in focus and morphing into a turnkey provider, the company did not stray from its competitive advantage, which rests on a decentralized decision-making model, a single-mindedness on margins and a robust balance sheet. This blend of adaptation while maintaining the core has enabled Major Drilling to weather adverse conditions better than most competitors.

After years of belt tightening, quarterly results announced last month suggested stability was finally at hand. The sharp sales decline witnessed over the past 18 months slowed to a trickle with revenue down only 3 percent compared with the prior year quarter. Meanwhile, gross margins improved from 23.8 percent to 27.5 percent, the net loss dropped by nearly half from $10.1-million to $5.3-million and cash from operations grew from $7.2-million to $8.3-million. Utilization rates ticked up and the company was profitable in many regions including North America.

The improvement seems to have boosted the confidence of insiders. From July to December, 2015, they were net purchasers to the tune of $476,000. It isn't a lone wolf buying either as a total of 11 insiders have been responsible for the surge. In our experience, when a bunch of folks privy to the inner workings of a company buy in quantity, it is usually an indicator of better things to come.

Given the intensification of negative sentiment, is the company really ready to turn the corner? The timing of the purchase for our Vice-President's Portfolio a little more than a year ago at $7.51 was clearly premature. Though careful consideration was given to averaging down last month during tax loss selling season, the conclusion was to stand pat until more positive evidence was available.

Major has been writing down assets for nearly two years. Last quarter's report was finally clear of impairment charges, but is this a pause or a reversal of the trend? We expect some of the company's peers to hit the wall and wind up operations. Although this scenario would reduce competitive pressure, it would throw equipment onto the market when buyers are few and far between. The current trading price of $4.47 looks attractive compared with a book value of $5.78, but that metric could be eroded if the carnage continues.

While our belief is that Major Drilling will survive these tempestuous times, we are far less confident in our ability to predict where commodity prices are heading. First-quarter results are generally weak as mining companies prepare their budgets, so this is a good time to watch and wait. There is lots of potential upside to this disciplined driller as our sell target range is $15.50 to $18.

Finally, we'd like to mention the 2015 results of our Contra the Heard portfolios. The President's Portfolio tackled tricky markets to a 13.9 percent gain, bringing the five-year annualized return to 25.7 percent. The Vice-President's Portfolio nudged up 2.5 percent, bringing the five-year annualized return to 8.7 percent.


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