Why I’d Buy Fresnillo plc And Randgold Resources Limited Over African Potash Ltd And Beowulf Mining plc

The last couple of years have been hugely challenging for the mining sector, with weak commodity prices leading to reduced profitability and weakening investor sentiment. While the recent past may be mirrored over the short-to-medium term, long term investors may wish to consider the purchase of mining companies that have brighter outlooks. That’s because in some cases they offer a relatively wide margin of safety and trade on very appealing valuations.

While things could realistically get worse before they get better for mining companies, that could mean buying companies that offer size, scale and profitability could be a shrewd move for investors. That’s because the larger mining companies may have the most appealing risk/reward ratios in terms of offering low prices and upward rerating potential, as well as a track record of profitability and relative financial soundness.

Going For Gold

Fresnillo (LSE: FRES) is among the largest silver producers in the world and Randgold Resources (LSE: RRS) has the same status among gold producers. With their share prices having fallen by 62% and 28%, respectively, since the start of 2013, it’s clear that they’re trading at a low ebb. That’s no surprise after their huge falls in profitability, with Fresnillo’s earnings per share (EPS) declining by 93% in the last three years and Randgold Resources’ EPS being 47% down in just two years.

While these EPS figures are hugely disappointing, both companies have been able to stay in profit throughout the price falls in gold and silver. And looking ahead to the next two years, they’re expected to post excellent growth numbers. For example, Fresnillo’s bottom line is forecast to rise by 158% this year and by a further 84% next year. This puts it on a price-to-earnings-growth (PEG) ratio of just 0.4, which indicates a share price recovery is on the cards. And, with Randgold’s earnings expected to rise by 22% next year, its PEG ratio of 1.1 is also highly appealing.

In The Slow Lane

Clearly, not all mining companies have the size, scale and production capabilities of Fresnillo and Randgold, which makes them a less appealing investment for now. Take African Potash (LSE: AFPO) and Beowulf Mining (LSE: BEM) that are a fraction of the size of their two sector peers. Many investors may be bullish on their long term prospects after their share prices have collapsed by 40% and 47%, respectively, since the start of 2013. Yet their appeal for most investors may prove to be limited.

That’s not necessarily because those long term prospects are disappointing, or that their strategies or management teams are poor. It’s merely a reflection of the current state of the mining sector that there are large-cap miners trading at exceptionally low prices and that offer the potential for growing profitability over the short-to-medium term. Furthermore, those large-cap firms offer greater diversity and financial strength than their smaller peers and, as such, appear to offer a more favourable risk/reward opportunity for the long term.

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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.