Foraco International ( Toronto - FAR ) -- Outlook Improves

Foraco (FAR.to $2.50) appears on track to report relatively poor Q4 results.  The company is the leading provider of high end drilling services used by mining companies to delineate potential targets.  Since the reserves haven't been exploited yet, drilling usually occurs in remote areas that require special expertise and original thinking.  Rates generally are elevated.  And demand tends to remain steady despite fluctuations in spot market commodity prices.  Mining companies normally expand their reserve base in a regular fashion.  Approximately 75% of Foraco's sales are provided by major mining companies.  So-called junior operators are more likely to cancel projects due to their reduced access to capital.  Foraco's performance nosedived during the second half of 2012 despite its relative strengths.  Worldwide demand for minerals skidded as third world economic growth stalled.  Foraco additionally suffered from management mistakes at its Chile subsidiary.  Those factors likely impacted December period results, as well.  A negative comparison is likely in the quarter.

New contracts are being signed at a solid clip.  A large portion of Foraco's contracts come up for renewal in the fourth quarter.  It appears the company has been successful in arranging work for most of its fleet of drilling rigs.  Prices probably are lower due to the industry's persistent weakness.  But a solid showing appears attainable in 2013, nonetheless.  Results will be reinforced by a series of acquisitions Forcao completed last year.  Those transactions took place after the industry declined, enabling Foraco to sign the deals at attractive prices.  Organic growth is likely to fall 10%-20% in 2013.  But overall sales are poised to increase 10% due to the acquisitions.  Income could advance 33%, bolstered by a return to profitability at the Chile subsidiary.

The long term outlook is uncertain.  If the world economy keeps struggling for several years the demand for commodities is certain to remain muted.  Even so, these shares could rise in value as Foraco's market share expands and free cash flow is invested in more accretive acquisitions.  If the "New Abnormal" winds down a more vigorous showing is possible.  Our projections assume a modest performance in 2013 as the U.S. and Europe endure an adjustment process to their government finances.  Once that foundation is established growth could re-accelerate.  In 2-3 years sales could reach $500-$600 million to support income of $.50-$.60 a share.  Applying a P/E multiple of 15x to the low end of the range suggests a target price of $7.50 a share, potential appreciation of 200% from the current quote.

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