The Motley Fool

Why I’d ignore the Glencore share price and buy this other 5% yielder

The share price of FTSE 100 mining and commodity group Glencore (LSE: GLEN) has fallen by about 25% so far this year.

Shareholders will be reassured to know that earnings forecasts for 2018 have remained stable over the last few months and are nearly 50% higher than they were one year ago. But volatile market conditions and concerns about the potential impact of a US-China trade war are putting pressure on valuations in this sector.

I believe there’s a second risk too. Companies in the mining sector have now recovered from the crash of a few years ago. Valuations have returned to normal levels, in my view. Unless the prices of key commodities such as coal, iron ore and copper rise sharply, growth from this level may be slower.

A final concern is that the firm is under investigation by the US Department of Justice for possible money laundering offences in Africa. The DoJ appears to be investigating as far back as 2007. So this investigation could eventually lead to a sizeable fine or settlement payout.

Growth + returns

Glencore has been targeting a return to growth through selected acquisitions, such as the $1.7bn purchases of the Hail Creek coal mine from Rio Tinto in August.

The group also plans to spend $1bn buying back its own shares during the second half of 2018. Management expects to return a total of $4.2bn to shareholders this year.

On balance, I think Glencore stock looks quite fairly valued at the moment. The shares trade on a 2018 forecast price/earnings ratio of 8, with a prospective yield of 5.5%. With earnings expected to fall slightly in 2019, I’d hold for income but would be reluctant to buy.

One stock I have bought

Personally, I’m more interested in the oil market at the moment. I believe there are a number of decent opportunities for investors in this sector.

One of my biggest stock holdings is oil services group Petrofac (LSE: PFC). Like Glencore, Petrofac is under investigation, in this case the UK’s Financial Conduct Authority. This remains a risk, but unless there’s more bad news, I think it’s already reflected in the share price.

What attracts me is the firm’s profit potential when the oil market returns to growth. Service providers like Petrofac have faced a lot of price pressure from their oil producer customers since 2015. And spending on growth projects has been very limited over the last few years.

At some point, history suggests that this will change and the oil sector will start spending more on growth projects. When this happens, I’d expect Petrofac to enjoy strong profit expansion for several years.

A good starting point?

Adjusted net profit rose by 20% to $190m during the first half of the year, despite a drop in revenue.

New orders worth $3.3bn were signed during the period, leaving the group with an order backlog worth $9.7bn. Although this backlog is down slightly from $10.2bn at the end of 2017, I think it’s close enough to suggest a stable outlook.

The shares currently trade on 8.4 times forecast earnings with a dividend yield of 4.8%. In my view this should be a good entry point for investors who want to profit when the oil market returns more actively to growth. I continue to rate this business as a buy.

Buy-And-Hold Investing

Our top analysts have highlighted five shares in the FTSE 100 in our special free report "5 Shares To Retire On". To find out the names of the shares and the reasons behind their inclusion, simply click here to view it right away!

Roland Head owns shares of Petrofac and Rio Tinto. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.