The past year wasn’t kind to any miner as collapsing commodity prices and sky-high debt sent share prices across the sector tumbling. Diversified producer Rio Tinto (LSE: RIO) was no exception, but now could be a great time to begin a position in what is one of the healthier commodity producers. At year-end, Rio’s net debt of $13.7bn represented a gearing ratio of 24%, better than competitors such as Anglo American or BHP Billiton. The company’s net debt/EBITDA ratio of 1.1 was also in line with BHP’s and ahead of the likes of Glencore.
Although Rio did post a loss in 2015, like nearly every large miner, its underlying operations remain solid. Iron ore, the company’s breadbasket mineral, posted $7.8bn in EBITDA on $15.3bn in sales due to low-cost-of-production assets. And while commodity prices will likely remain subdued for some time as Chinese demand cools, Rio’s relatively low debt levels and low-cost assets should serve it well. Valuation wise, Rio also trades at a discount to rivals and offers a higher dividend, reason enough to make Rio my pick in the resource sector.
Order backlog
Another company in a highly cyclical industry trading at a low valuation is Petrofac (LSE: PFC), which as its name suggests, is in the oil & gas industry. This oil services company focuses on Middle Eastern national oil companies, which have continued to pump oil at prodigious rates to make up for falling prices. Over the past year Petrofac’s order backlog rose 10% to a record $20.7bn giving the company several years of visible revenue.
Debt is an issue for Petrofac as gearing stood at 56% at year-end, but strong cash flow last year brought net debt down from $733m to $686m. The company is also recovering from a disastrously over-cost offshore project, thankfully now finished, that sent net profits down to $9m last year. However, with this project behind it, analysts are expecting a significant rise in profits this year. Shares are trading at 9 times forward earnings and offer a 5.8% yield, which could be attractive to investors looking for exposure to the industry at a low point.
Growth potential
One firm that doesn’t have to worry about cyclical demand for its products is British American Tobacco (LSE: BATS). And, contrary to what would be expected, organic volume actually increased for BATS to the tune of 2.4% in the past quarter. While this was lower once adjusted for inventory movements, it shows that BATS has growth potential in developing countries where incomes are growing. And although governments across the developed world are increasing regulations on advertising, including the introduction of plain packaging rules in Australia and the UK, BATS has overcome similar hurdles before.
Strong cash flow from growing volumes and impressive pricing power mean dividends have continued to grow for BATS and yielded 4.1% last year. Despite shares trading at a relatively pricey 18 times forward earnings, BATS is a steady winner that has rewarded shareholders well for decades and growing demand in developing markets makes me confident this won’t change any time soon.
