Foraco ( Toronto - FAR ) -- Scouting for Mineral Deposits

Foraco ( FAR $4.75) is a leading provider of exploratory drilling services for mining companies.  The company is hired by resource producers to delineate potential targets, estimate the degree of difficulty involved, and resolve any water issues.  Foraco operates about 200 rigs around the world.  It trains and provides its own crews, which generally are in short supply due to surging exploration activity.  Industry spending has expanded more than 200% over the past decade, fueled by booming demand for metals in Third World markets.  Foraco added nearly another 100 rigs in March when it purchased 51% of a major drilling services provider in Brazil.  Approximately 85% of revenue is generated by contracts with major mining companies.  The balance is derived from smaller operators that typically sign short term deals, enabling Foraco to keep its crews busy between major engagements.  More long term contracts are being signed, which is bolstering revenues and margins by reducing downtime.  Demand for exploratory drilling is continuing to grow despite the threats posed by economic uncertainty and volatile commodity prices.  That trend is apt to continue as consumption of metals outstrips production over the next several years.

Foraco specializes on the most technically challenging targets.  That's enabled the company to earn above average margins throughout its history.  It now is helping to expand market share, as well.  Like in the energy business, new discoveries increasingly are being found in remote locations that involve specialized talent.  In 2011 South America accounted for 42% of revenues; Africa, 28%.  Russia and Canada represent most of the balance.  Foraco has established a presence in those geographies through a combination of internal growth and effective acquisitions.  Most of those transactions, similar to latest deal in Brazil, involved purchasing a partial controlling stake to begin with.  A few years later, an option to buy the rest was exercised. 

Growth has been explosive.  Sales and earnings were unchanged in 2009 following the worldwide banking crisis.  Sales climbed 37% in 2010 as the industry regained its footing.  Another 84% gain was registered last year.  Earnings recovered from a temporary dip in 2010, jumping 162% to $.34 a share last year.  Backlog expanded 44% to $418 million, laying the groundwork for another strong performance in 2012.  Bolstered by the recent acquisition in Brazil, we estimate sales will improve 38% to $415 million to provide earnings of $.55 a share (+62%).

In 2-3 years income could attain $1.00 a share on sales of $600 million.  Applying a P/E multiple of 15x to those earnings suggests a target price of $15 a share, potential appreciation of 215% from the current quote.  A higher valuation is possible if environmental stress creates water shortages in Africa or elsewhere.  Foraco currently generates 5%-10% of sales by drilling wells for drinking water.  That business has the potential to exceed mining over the long haul if global warming creates substantial droughts.  Management owns 42% of the stock.  Foraco is based in Marseilles, France.

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