After a troubled 2015, many investors are wondering whether a number of resources companies will make it through 2016. After all, profitability has come under severe pressure and the financial outlook for several resources stocks is somewhat uncertain.
Silver to generate more gold
The world’s largest silver producer Fresnillo (LSE: FRES) has been hit hard in recent years by a falling silver price. This has put its profitability under severe pressure, with pre-tax profit declining from over £1bn in 2011 to just £167m last year. Clearly, this is a huge disappointment for the company’s investors. But crucially, Fresnillo has remained firmly in the black throughout the era of a plunging silver price. And looking ahead to next year, it’s expected to post meaningful earnings growth.
In fact, Fresnillo is forecast to report a rise in earnings per share of 162% next year, followed by further growth of 81% the year after. Not only does this indicate that it’s very likely to survive the current downturn, but also that it’s worth buying at the present time. That’s because it trades on a price-to-earnings growth (PEG) ratio of only 0.4 and, while its forecasts are likely to remain volatile due to their high dependency on the price of silver, a sufficiently wide margin of safety appears to be on offer.
Furthermore, Fresnillo has a debt-to-equity ratio of just 34%, which indicates that a rising interest rate is unlikely to squeeze profitability to a large extent in future years.
Hunting for growth
Similarly, Hunting (LSE: HTG) has a very modestly leveraged balance sheet, with it having a debt-to-equity ratio of just 18%. This means that, while profit falls are expected in the current year, Hunting’s interest coverage ratio is likely to remain relatively high. In fact, in its half-year results it stood at 4.2 and this indicates that it’s likely to survive a further downturn in operating profit over the medium term.
However, Hunting’s bottom line is expected to recover somewhat in 2016, with earnings growth of 54% being pencilled in by the market. Not only would this provide additional headroom when making debt interest payments, it would also mean that Hunting’s shares are relatively cheap. For example, with them trading on a PEG ratio of 0.6, now seems to be an opportune moment to buy a slice of them for the long term.
Under pressure
Meanwhile, Lonmin (LSE: LMI) has been in a highly precarious financial situation of late, with the company undertaking a rights issue in order to continue its operations. As the company stated earlier this week, a 70% take-up of the company’s new shares to qualifying shareholders under the rights issue means it will now be able to deliver on its strategy and business plan.
Although this is positive news, Lonmin is expected to deliver a pre-tax loss of £30m in 2016 and this could put its shares and financial outlook under a degree of pressure. And with the potential for further falls in commodity prices, Lonmin’s outlook is arguably less certain than for Fresnillo and Hunting. Therefore, while Lonmin may still be appealing for less risk-averse investors after its rights issue has given it the opportunity to survive in 2016, there appear to be better risk/reward ratios on offer elsewhere in the resources sector.
