Shares in diamond miner Petra Diamonds (LSE: PDL) edged higher on Monday morning after the group said that profits rose by 12% to $66.8m during the year ending 30 June. Production rose by 16% to 3.7m carats, slightly ahead of Petra’s previous guidance.
Capital expenditure rose to $324.1m, as activity peaked on expansion projects at the Finsch and Cullinan mines. Both of these projects are expected to deliver more than 1m tonnes of ore in the current financial year, boosting both cash flow and profits.
Indeed, while Petra shares trade on a trailing P/E of about 16, current broker forecasts indicate that Petra’s profits could double this year. This puts the stock on a forecast P/E of just 8. If the firm can deliver on its promises and the diamond market remains stable, the shares could be cheap at current levels.
However, before you hit the buy button on Petra, it’s worth remembering that the firm’s expansion is being funded by debt. One consequence of this is that Petra wasn’t allowed to declare a final dividend for last year.
Its net debt rose by 124% to $384.8m last year. This sharp rise in debt wasn’t matched by a corresponding rise in earnings and means that Petra didn’t satisfy the dividend conditions imposed by its lenders.
Although Petra is still complying with the other covenants relating to its loans, these have already been relaxed once. These revised covenants are only temporary, so Petra is now under pressure to deliver improved performance over the next 12 months.
I think the shares’ low forecast P/E makes sense at this point. I rate Petra as a hold, until the benefits of recent investment start flowing through to the firm’s financial results.
Bigger might be better
In contrast to Petra, iron ore and copper giant Rio Tinto (LSE: RIO) has no issues with debt. The group’s net debt has fallen by nearly a third since peaking in 2012, and profits are expected to bounce back strongly this year.
Rio shares currently trade on a forecast P/E of 15 and offer a prospective yield of 3.7%. This payout is expected to remain flat in 2017, as earnings growth slows to about 7%.
However, Rio’s two main commodities, iron ore and copper, are both in the middle of a prolonged downturn. It’s worth remembering that this won’t last forever — and when market conditions improve, Rio’s large-scale, low-cost assets will mean that profits should rise fast.
City analysts are also turning steadily more positive on Rio. Earnings forecasts for 2016 have risen from a low of $1.29 per share in February to $1.92 per share today. These forecasts tend to lag events, so a trend of rising forecasts is often a sign that further gains are likely.
In my view, Rio offers good long-term potential for both income and steady growth. Indeed, I rate Rio as one of the best big-cap buys in the mining sector. I believe this stock could well beat the wider market over the next few years.
