The New Year has shown no let-up in the disappointing performance of the resources sector, with a range of its constituents posting significant losses even after just a few days have passed. Of course, the FTSE 100 has also made a poor start to the year, being down over 2% at the time of writing. So investors could be forgiven for avoiding buying shares at the moment – especially in the resources sector.
In the short run, things could get worse before they get better. Therefore, investing in resources companies over a short time horizon doesn’t appear to be a sound move. However, given the valuations on offer at a number of resources companies, buying for the long term appears to make sense even when the risks of further falls are taken into account.
Hunting cost cuts
For example, energy services company Hunting (LSE: HTG) trades on a price-to-earnings growth (PEG) ratio of just 0.6, which indicates that its shares offer significant future upward rerating potential. Clearly, the deferment and cancellation of capital expenditure is hurting Hunting’s profitability and, realistically, this situation is likely to be maintained in the short run as oil and gas companies seek to cut expenditure.
As a result, Hunting is mirroring its customers and expects to reduce its annual costs by around $50m – mainly due to staff cuts. While this will aid profitability, the coming months are still likely to be highly challenging for the business. While its long-term future may offer capital gain prospects, it remains a purchase that may only be of interest to less risk-averse investors.
Similarly, Premier Oil (LSE: PMO) is suffering from a lower oil price with its bottom line expected to remain in the red when it reports its 2015 results. However, 2016 could prove to be a better year for the company since it’s forecast to deliver a pre-tax profit of £35m and this turnaround has the potential to stabilise investor sentiment in the stock.
As reported in its half-year results, Premier Oil continues to make cost savings and in the first half of 2015 was able to reduce operating costs by 30%. This, alongside amended financial covenants, provide additional financial security for the business and mean that Premier Oil has the scope to deliver on its strategy. With a sound asset base and a low valuation – as evidenced by a price-to-book value (P/B) ratio of just 0.25 – Premier Oil could prove to be a profitable investment over the medium-to-long term.
Work in progress
One resources stock that has been in the headlines in recent months is Glencore (LSE: GLEN), with it having raised funds to reduce its balance sheet leverage in a bid to improve its financial stability. Clearly, this has done little to curb declining investor sentiment, with Glencore’s shares having fallen by 24% in the last three months. However, the company’s recent trading update showed that it’s making encouraging progress.
For example, Glencore is well on the way to achieving the cost savings that it has previously outlined, while its trading business continues to deliver relatively resilient profitability. Certainly, further falls in commodity prices will hurt its outlook. But with Glencore now trading on a price-to-earnings (P/E) ratio of 13.4 and forecast to increase its bottom line by 19% in 2016, it could be a profitable, albeit highly volatile, long-term buy.
