The resources sector may have experienced a respite in recent months, but it still faces an uncertain future. Of course, this has always been the case since commodity price falls can happen at any time and go on to hurt the profitability of resource-focused stocks. However, with investors being keenly aware of this fact following the difficulties over the past couple of years within the resources sector, investor sentiment may turn much faster than it otherwise would do if commodity prices come under pressure.
Clearly, BHP Billiton (LSE: BLT) is one of the better diversified resources companies on the FTSE 100. However, even its share price has been severely hurt by the downturn and if commodities as a whole endure a difficult period, BHP’s share price could reverse the gains of the last three months where it has risen by 38%.
Looking ahead, BHP is forecast to increase its bottom line by 180% in the next financial year. And even after such strong share price growth of recent months, BHP’s improved financial performance does not appear to have been fully priced-in by the market. In fact, it trades on a price-to-earnings-growth (PEG) ratio of just 0.2 and this indicates that it has a relatively wide margin of safety. As such, and while a sustained fall in the price of commodities could cause its shares to fall, BHP still seems to offer a very enticing risk/reward ratio.
Similarly Amec Foster Wheeler (LSE: AMFW) appears to be worth buying despite the risk from continued lows in commodity prices that have hurt investment activity in the sector. In response to the difficult trading conditions, Amec Foster Wheeler has initiated the sale process for multiple non-core assets and while its order book declined in value by 3% during the first quarter of the year, the company is still forecast to increase its bottom line by 4% next year. This could help to improve investor sentiment and show that even during challenging trading conditions, Amec Foster Wheeler is able to respond positively.
With Amec Foster Wheeler trading on a price-to-earnings (P/E) ratio of just 9.4, there’s significant upward rerating potential on offer. And with its shares yielding 4.4% from a dividend that’s covered 2.4 times by profit, it seems to be a sound buy.
Meanwhile, Cairn Energy (LSE: CNE) is a resources stock with huge potential to deliver long-term profitability. Its asset base is highly enticing and with it having a large cash pile, it appears to be well-funded. During a period where investor sentiment is rather low, Cairn’s strong balance sheet is a major plus for the company and its investors.
As with BHP and Amec Foster Wheeler, a sustained fall in the price of commodity prices could hit Cairn’s share price very hard. And the problem it faces is that because investors are somewhat nervous regarding the outlook for the resources sector, they may seek out companies perceived to be less risky than Cairn. In other words, businesses that are profitable and trade on low valuations. As such, and while Cairn could be a worthy buy for the long term, there seem to be better options elsewhere within the resources space.
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Peter Stephens owns shares of BHP Billiton. 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.