I have said in the past that I believe mining stocks are inherently dangerous. Their problem is cash flow.
Think about the infrastructure needed to begin operating a mine. Getting all the plant and machinery into place, and accessing the mineral, comes at a huge expense. And this is before the company is generating any cash. These start-up expenses usually have to be funded by debt. This difficult scenario can be the downfall for many mining operations.
Did the same happen to Sirius Minerals (LSE: SXX)?
Fellow-Fool, Alan Oscroft, has noted that Sirius Minerals did not have adequate funding in place to begin production.
Initially, the picture might have seemed appealing to investors. The company was sitting on potash reserves and had customers lined up. The problem was that it would have been several years before maximum output was reached.
The situation for Sirius Minerals has recently changed. Mining giant Anglo American has proposed a takeover offer, which still needs agreement from shareholders.
In hindsight, investing in Sirius Minerals might have been a gamble. I would rather invest in companies with a strong track record.
This business could fit the bill.
Royal Dutch Shell
Lower oil and gas prices have caused some damage to the Royal Dutch Shell (LSE: RDSA) share price.
Over the past year, its stock price has plummeted by 20%. This will come as no surprise to investors who read that Shell’s fourth-quarter underlying profits were 48% lower than the previous year, at $2.9bn.
Although free-cash-flow at $5.4bn was 67.7% lower than last year, cash generation is still substantial.
The drop in profits was partly due to lower oil and gas prices.
Shell is currently undergoing a $25bn share buyback programme. When a company does this, I often believe it is a sign that the business thinks the shares are undervalued. With the shares trading at a price-to-earnings ratio of 12, they could be slightly undervalued.
But as Paul Summers points out, Shell is often not bought for its potential growth. Instead, people will be more interested in Shell’s lumpy dividend, which is currently around 7%. Famously, this has not been cut since the Second World War.
For long-term investors, it will be interesting to see how Shell shifts its focus to renewable energy. Over the next few decades, demand for oil may dry up before the supplies do.
In a way, with Shell’s profitability being linked so closely to the price of oil, an element of its fate is taken out of its hands. However, it does appear that the business has managed costs well.
With oil prices fairly low, now might be a good time to buy shares in the company. In any case, it is a very different beast to Sirius Minerals, if only because of its generous dividend.
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T Sligo has no position in any of the shares mentioned. 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.