Fitch Ratings has upgraded Australia-based Emeco Holdings Limited's Long-Term Issuer Default Rating (IDR) to 'BB-' from 'B+'.
The Outlook is Stable.
The upgrade reflects the improvement in Emeco's revenue visibility and defensibility, through diversifying its service offerings, increasing contract tenures, and improving its customer and commodity diversification. The rating also incorporates the benefits that the reduction in the cost base and more flexible fleet and cost structure provide - particularly in the more cyclical mining services industry.
The Stable Outlook reflects our expectation that Emeco will maintain a conservative financial profile, with EBITDA net leverage remaining below 1x through the cycle. It also recognises that the company has addressed underperformance in a few contracts. Further, Fitch believes that Emeco is well-positioned to benefit from rising demand for minerals amid the green energy transition, which will support ongoing demand, particularly as the company increases its exposure in Western Australia.
Key Rating Drivers
Improved Revenue Visibility: Emeco's revenue visibility has benefited from rising service revenue, customer and commodity diversification, and the ability to switch its fleet between commodities. Service-based revenue has increased as a proportion of revenues - these contracts are typically longer-term and more integrated in a miner's operations - meaning they are less volatile in weaker commodity markets. This complements the diversification achieved across the customer base and exposure across commodities - in particular, raising its exposure to gold to around 40% of revenue.
This improved visibility has also been enhanced by Emeco's strategy to build a commodity-agnostic fleet, which it is able to move between projects, regions and commodities to respond to changes in demand. This was demonstrated recently in replacing some of its lost rental earnings by moving trucks to fill demand requirements in Western Australia following weakness in coal markets in late-2020, which saw demand fall on Australia's east coast as coal producers reduced mining activity.
Defensive Cost Structure: Fitch believes that the flexibility built into Emeco's asset base and cost structure will allow the company to protect its financial profile during commodity downturns. Emeco has increased the level of integration in its customers' operations - thereby improving revenue visibility - while its services continue to revolve mainly around equipment hire and related services, which make it more vulnerable than peers that provide integrated or full-service offerings during weak commodity markets.
We believe Emeco's in-housing of rebuild and maintenance functions provides an improved ability to manage through the cycle. The structure allows the company to control its maintenance schedule and plan actively for any significant capex - while also increasing the flexibility of the company's costs. In commodity downturns accompanied by weaker demand, Emeco can reduce maintenance costs and sustaining capex to a level commensurate with activity, which would allow it to remain profitable and minimise cash outflows to protect its balance sheet.
Strong Financial Profile: Emeco employs a conservative financial profile, with target net debt/EBITDA leverage of below 1x. Fitch-calculated EBITDA net leverage at 30 June 2022 (FYE22) was 0.8x, well below the negative sensitivity of 1.5x. We expect Emeco to keep leverage below 1x and maintain a conservative balance sheet to manage its business through the cycle. In addition, Emeco's reduction in exposure to thermal coal to 12% of revenues at FYE22 underscores its commitment towards a sustainable operation, ensuring access to capital markets with reasonable funding costs.
Margin Challenges in FY23; FY24 Improvement: Fitch expects isolated underperforming contracts and receivables issues in Pit'N'Portal to lead to lower EBITDA margins in FY23. Labour challenges will also continue to affect operations, and time lags in rise and fall mechanisms to offset inflationary pressures will mean that margins only begin to recover in FY24. However, the rental business' operating utilisation and margin are likely to improve, as disruptions in Western Australia ease, although rental margins in Western Australia and the overall business are expected to remain below historical levels.
Supportive Industry Conditions: We expect Australian mining production volume to remain strong over the next few years, particularly in hard-rock commodities and as demand rises for materials crucial to the green energy transition, such as lithium. Emeco is well-positioned to capitalise on this. It has demonstrated its ability to win contracts with the significant growth in the Pit'N'Portal business, and was able to successfully redeploy assets from the coal-focused east coast to Western Australia to take advantage of project wins and rising demand across a number of commodities.
Derivation Summary
Emeco's rating could be compared with that of Indonesia's PT Bukit Makmur Mandiri Utama (BB-/Stable). The upgrade of Emeco's IDR highlights the improvement in revenue visibility through better diversification across customers and commodities, and an increase in service-related revenues with the growth of its Pit'N'Portal segment. These factors have narrowed the gap to Bukit Makmur's stronger business profile, which stems from its revenue visibility and stable operating profile, reflecting long-term contracts with miners and its diversified service offerings at various production stages. However, Bukit Makmur has high customer concentration risk, with around 80% of its volume comes from three counterparties, and commodity concentration risk to the highly cyclical Indonesian coal contracting industry, which has previously led to volatility in its earnings and leverage.
Emeco has a better financial profile than Bukit Makmur, and the company has demonstrated its commitment to maintaining a conservative balance sheet. We believe that this offsets Bukit Makmur's slightly stronger business profile, and supports both issuers' ratings at the same level.
Key Assumptions
Fitch's Key Assumptions Within Our Rating Case for the Issuer
Operating utilisation rate to remain stable to FY26 to around 60% due to tight rental-equipment conditions, commodity fungibility of Emeco's fleet, and strong activity levels in the mining sector, but reflecting Fitch's expectations of a moderation in commodity markets.
Net capex at around 20% of revenue from FY23-FY26;
25%-40% of operating net profit after net tax to be returned to shareholders, in line with management guidance.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
An upgrade is unlikely while Emeco retains its current level of exposure to the more cyclical equipment rental and related services sub-segment of the mining services market and at its relative smaller scale.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A deterioration in operating performance, including a decline in the operating utilisation rate and loss of major contracts.
EBITDA net leverage exceeding 1.5x for a sustained period.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Adequate Liquidity: Emeco's next significant debt maturity is in July 2026, which is the AUD250 million 6.25% senior secured note. The company had a committed undrawn revolving facility of AUD97 million due September 2023, and cash in hand of AUD60 million at end-2022. We also expect Emeco to generate positive cash flow before dividends over the next four years, demonstrating its ability to fund operations internally.
Issuer Profile
Emeco, founded in 1972, is one of the leading earthmoving equipment rental companies listed on the Australian Securities Exchange. The company has operations in all key mining regions of Australia, and its customers include mining companies and contractors across gold, coal, copper, bauxite and iron ore.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
EMECO HOLDINGS LIMITED 
