Boart Longyear (BLY) provides contract drilling services to the mining, environmental, infrastructure, and energy industries.

The Drilling Services business provides drilling services to the mineral exploration, development and production, environmental, infrastructure and energy markets.

The Drilling Products business designs, manufactures and sells drilling equipment such as drills and support systems, as well as bits, rods and all requisite tooling.

China continues to slow

Yesterday, the HSBC Final Manufacturing PMI confirmed China's manufacturing sector contracted sharply in June. The PMI reading of 48.2 was the weakest since September 2012.

Deteriorating business conditions, including falling customer orders and rising inventories, were blamed for the poor manufacturing result. Another worrying trend that has emerged in recent weeks has been a tightening in Chinse credit markets.

Since mid-May, Chinese banks and financial institutions have been wary of lending to each other, leading to sharp rises in inter-bank borrowing rates.

Weaker credit, combined with Beijing's reluctance to stimulate the economy, is likely to keep manufacturing in the doldrums for a little while longer.

Poor operational update

BLY warned yesterday that it indeed was facing worsening trading conditions, particularly relating to its Drilling Services business, which is suffering from weak rig utilisation rates and customers delaying their drilling programs.

The group said FY13 revenue and EBITDA were likely to miss consensus estimates of a US$1.355 – US$1.556 billion range for revenue and a US$176 - US$211 million range for EBITDA.

In FY12, BLY reported revenue of US$2.01 billion and EBITDA of US$254 million. Not only is the group on track for a massive year-on-year drop in revenue and operating earnings, but it was forced to seek assistance from lenders regarding its bank debt facility.

BLY was allowed to reduce its leverage ratio (gross debt / EBITDA) requirement from 4.75x in FY13 to 3.50x by FY16. In return the company must give up security over a greater range of assets, has to pay a higher rate of interest and increase the pace of principal repayments.

Outlook

China's manufacturing sector has entered contraction territory and its export sector is buckling under the weight of tepid global economic growth. As a result, miners are likely to curtail their capital expenditure in response to weaker demand.

BLY is therefore unlikely to see a pickup in demand for its drilling products, whilst drill rig utilisation rates are likely to continue heading lower. At the end of FY10 rig utilisation rates were 75%, but are heading towards 50% at the end of FY13, according to BLY.

Although BLY's revised covenants allow it space to breathe if EBTIDA stays low in coming years, the fact it must pay higher interest is worrisome in a period where lending rates are expected to rise.

BLY must convince the market that it has measures in place to slash costs and/or that revenue is likely to rebound. We don't think the latter is likely to occur any time soon.

Net profit margin has shrunk from 7.9% in FY11 to just 3.4% in FY12. Higher interest expense without an offsetting reduction in operational expenses is likely to heap further on the group's margins.

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