One of the challenges of investing in resources companies is that earnings visibility is very poor. Certainly, a company operating in that space can become hugely efficient, keep costs to a minimum, keep debt levels low and diversify but, ultimately, profitability is mostly dependent upon the price of the commodity that they sell. As such, even though output of various commodities has increased across the resources sector, profitability is still heavily down.
This, then, is a problem which is omnipresent in the oil and gas and mining sectors. However, with the price of these commodities having fallen so heavily, it has been brought into much sharper focus and, once again, investors are very aware that external factors matter greatly when it comes to investing in resources companies.
However, the key component of investing in resources companies remains the same as when commodity prices were much higher. In other words, investors require a margin of safety so that if profitability disappoints, there is a degree of share price support, and if it beats guidance then there is scope for an upward movement in the company’s share price.
One stock that has a very wide margin of safety is FTSE 100 mining stock Glencore (LSE: GLEN). It is forecast to increase its earnings by around 50% next year and, if this level of growth is met, it would mean that Glencore trades on a price to earnings (P/E) ratio of just 11. This indicates that, even though the outlook for the wider mining sector is poor, there is still considerable upward rerating potential on offer via Glencore.
In addition, Glencore also has a yield of 6.9%, which is among the highest in the FTSE 100. Certainly, there is a good chance that the level of shareholder payouts will be cut over the medium term – especially if Glencore fails to produce the earnings figures that are being expected. However, even if dividends are halved, Glencore is likely to remain a relatively appealing income stock with a wide margin of safety.
Similarly, Iraq/Kurdistan-focused oil and gas producer Genel Energy (LSE: GENL) may have a very challenging short term outlook, but its valuation appears to adequately take this into account. Like Glencore, it trades on a relatively low forward P/E ratio, with Genel’s rating currently standing at just 12.2. This indicates that the potential challenges involving the persistent military conflict in the region as well as delays in receiving monies owed for past sales are factored into the company’s current share price. That’s because, with a strong management team and a very high quality asset base, Genel Energy could be worth a lot more than is currently the case.
Meanwhile, Xcite Energy (LSE: XEL) continues to suffer from declining investor sentiment. Evidence of this can be seen in its share price performance in 2015, with it being down 11% year-to-date. Looking ahead, a low oil price environment could work for Xcite, since it is likely that costs across the industry will fall in line with reduced demand and, for an exploration play such as Xcite, this seems to be a major positive.
However, it still has a decent amount of debt that needs to be serviced and, while its asset base is somewhat appealing, it may struggle to spark a significant improvement in investor sentiment over the medium term. As such, and while it is a stock to watch, it may be worth waiting for a keener share price before buying a slice of Xcite Energy.
