Cash is king.
That old maxim holds as true for investors as it does for anybody else.
Which is why the recent decision by Capital Drilling (LON:CAPD) to start paying out dividends marks a real step change in the history of the company.
Times are tough – no one’s denying that.
Indeed, the very first bullet point on Capital’s corporate presentation speaks of metals being at “multi-year lows.”
That’s had an impact on Capital too, as first half revenues in 2015 came in significantly down on the number delivered in the corresponding period in 2014, and rig utilisation rates have dropped to a historic low of 34%.
But the payout of US$4mln in dividends since May of this year marks a real statement of intent.
The board is now resolved to pay out between 25% and 50% of the company’s free cash flow as dividends and that policy ought to provide a copper-bottomed floor to the share price.
Because although first half revenue dropped by more than a quarter over the past 12 months, the comparative number for net cash generated from operating activities was far less severe.
In the first half of 2015 the company generated US$9.6mln in cash, as against US$10.8mln generated in the first half of 2014.
And because Capital now has more rigs than it can currently deploy, investing activity has dropped away, allowing more cash to go towards paying down debt and paying out dividends.
What’s more, third quarter revenue was marginally up on the second quarter which could well indicate that the market is stabilising.
“We’re operating under some pretty heavy headwinds,” says chairman Jamie Boyton.
“But the message that we’re marketing is that while the conditions are challenging the company is performing well. We’ve had three consecutive quarters of small growth in the revenue line.”
But that’s not the reason why the board feels confident in setting out a longer-term dividend strategy.
Rather it’s because the company’s customer base is built around several blue-chip names with which it has multi-year contracts.
So although it may buckle a bit if commodities markets go south, Capital Drilling is in no way beholden to the whims of short-term sentiment.
In Mauretania the company has a contract with one of the world’s larger gold miners, Kinross (TSE:K) that runs until the end of next year.
In Egypt, the company has a contract with Centamin Egypt (LON:CEY) until 2020.
In Botswana, the company has a contract with Khoemacau Copper Mining until the end of next year.
And in Tanzania the company has a contract with AngloGold Ashanti (JSE:ANG) that lasts until 2020.
Between them, those four companies account for around 90% of the current revenue stream to the end of next year and around 70% of revenues ahead to 2020.
That’s enough to underpin some pretty robust and meaningful forecasts as to cash flows and dividends and allows for real confidence among the company’s lenders too.
Earlier this year, Capital was able to renegotiate a debt refinancing without much fuss.
The lender was Standard Bank – like Capital, an Africa specialist.
The due diligence team at Standard will have noted the long-term contracts that Capital already has in the bag and also that its rig utilisation rates are running at a historic 35% low.
That means that the potential for growth if activity in the mining sector does pick up is huge.
At the moment around 75% of revenue comes from what Capital Drilling’s chief executive Mark Parsons calls “production contracts” – work like grade control or blasting that needs to be undertaken by mines that are already in production.
If the exploration activity in the sector were to pick up, then Capital’s business would receive a real boost. There’s already a little bit of new exploration work trickling in, according to Mark Parsons.
No-one’s expecting an imminent sector turnaround, but when it comes, Capital will be ready.