I’m probably not alone in keeping a close eye on the resources sector right now. At some point, there could be an enticing contrarian opportunity.
Take small-cap platinum miner Lonmin (LSE: LMI), for example. The plunging price of platinum has seen profits evaporate, losses mount and the share price run itself into the ground. The final nail in the coffin for existing shareholders was a net $370 million rights issue designed to represent around 98% of the enlarged firm’s issued share capital — I think it’s fair to say that 2015 wasn’t the best of years for Lonmin or its shareholders.
Is the worst behind Lonmin?
Does this situation make your contrarian antennae twitch though? Not mine, but it does make my barge pole wobble. The old Lonmin is effectively dead and buried. This new capital injection means that whatever plans the firm has from here will ‘benefit’ those that chose to reinvest in the firm rather than those that didn’t.
The investing catastrophe that is Lonmin underlines just how fragile a firm’s business model can be in the resources sector. If you were contemplating starting a business from scratch, would you agree to these terms for the business model?
1. The business must be capital-intensive.
2. You will not be allowed to set your own price for your product.
That doesn’t seem attractive. In fact, it seems downright risky.
I have no conviction or confidence that the price of platinum will rise or remain at an economically viable level for Lonmin’s trading, so I’m avoiding the shares.
A far superior business
I’m more attracted to FTSE 250 constituent DCC (LSE: DCC), which is an international sales, marketing, distribution and business support services firm. Unlike Lonmin, DCC enjoyed a cracking 2015 with a double-digit uplift in earnings and a share price that shot up by 60%.
Last year, DCC earned around 54% of its operating profit transporting oil and liquefied petroleum products. However, that’s not the only string to the firm’s bow. Around 22% of operating profit came from technology products, 18% from healthcare and 6% from a range of recycling, waste management and resource recovery services.
DCC strikes me as a firm that rolls its sleeves up and does the things that people need done — for a price, of course. And it’s a price that DCC determines itself. On that basis, DCC’s business model is far superior to Lonmin’s and that happy situation shows up in the financial results DCC achieves:
| Year to March | 2011 | 2012 | 2013 | 2014 | 2015 |
|---|---|---|---|---|---|
| Revenue (£m) | 7669 | 8908 | 10,573 | 11,045 | 10,606 |
| Net cash from operations (£m) | 126 | 151 | 168 | 243 | 270 |
| Pre-tax profit (£m) | 167 | 111 | 133 | 150 | 147 |
Revenue growth produces rising cash flow, which is what really matters with a growing business. The profits produced enjoy good support from all that generated cash, which is a major sign of a strong business.
At today’s 5650p share price, we can pick up DCC shares on a forward price-to-earnings ratio of just over 20 for year to March 2017. Meanwhile there’s a forward dividend yield of 1.9% with the payout covered 2.6 times by forward earnings, which City analysts expect to rise 11% that year.
I’d rather take my chances with DCC than with Lonmin, and I think there’s a good chance the firm’s superior business model could outperform Lonmin’s in the longer term and perhaps during 2016, too.
