While there is a considerable amount of money to be made in turnaround stocks and turnaround sectors, it can be very difficult to catch a falling knife. Certainly, a lowly priced company with downbeat near-term prospects can see its valuation rise due to either improved trading conditions or a refreshed strategy. However, in many situations, things can get a lot worse – and never get better.
Clearly, the resources sector has faced unprecedented problems and pressures in recent years. For example, the price of gold has dropped by a third in the last four years, the price of iron ore is close to a ten-year low and the price of oil has been more than 50% below its level from last year. And, while the long term outlook for all three commodities, as well as the wider commodity sector, may be positive, in the short run there is likely to be further volatility and more pain for investors in the sector.
That’s why it is crucial to find the companies that can come through such a major challenge in reasonable shape and ready to take advantage of an upturn – whenever that might be. However, the likes of Gulf Keystone Petroleum (LSE: GKP), Cairn Energy (LSE: CNE) and Hochschild Mining (LSE: HOC) do not appear to fit the bill.
For starters, investor sentiment is extremely negative towards all three stocks. Evidence of this can be seen in their share price performance of the last five years, with the three companies seeing their valuations fall by 56% (Gulf Keystone), 83% (Cairn) and 68% (Hochschild). While this in itself is not a reason to avoid them, it means that there will need to be a significantly positive catalyst to not only stabilise their share price performance, but to then turn the market’s view of them around so that they can reverse their recent declines.
And, looking at their prospects, it is difficult to see that happening. For example, Hochschild has been a loss-making business in each of the last two years and is expected to continue this trend in the current year. Next year, the company is forecast to move into profitability which, while excellent news, appears to already be priced in. That’s because Hochschild trades on a forward price to earnings (P/E) ratio of 29.4, which does not indicate good value for money for a company that has such a disappointing track record.
Furthermore, Cairn is expected to be in the red for the next two years, following five years of losses. Certainly, it has a good asset base and positive news flow could help to boost its share price in the short to medium term. However, while a low oil price makes capital expenditure cheaper than in the past, it also means that Cairn’s relatively high cost prospects in the North Sea are even less favourable and less economically viable compared to opportunities elsewhere. Therefore, unless the oil price moves significantly higher, Cairn could struggle to see a marked improvement in investor sentiment moving forward.
Meanwhile, Gulf Keystone Petroleum remains one of the riskier companies in the resources sector. Its future is largely dependent upon the outcome of the situation in Iraq/Kurdistan, with its operations being focused on that region. And, while Gulf Keystone Petroleum has coped admirably thus far, its future remains too dependent upon external factors that are very volatile for it to be a viable investment opportunity at the present time. In other words, operating in a conflict region makes its future prospects extremely difficult to forecast and its operations susceptible to sudden and severe setbacks.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.