Investing in the resources sector requires a great deal of courage at the present time. That’s because the outlook for the sector is highly uncertain and, realistically, the falling profitability and declining investor sentiment which have characterised the last couple of years could continue into 2016.
In fact, iron ore miner Rio Tinto (LSE: RIO) is expected to report a slump in its bottom line of 48% in the current calendar year. While there had been hopes that next year would see an improvement in its financial performance, guidance has been downgraded and the market now expects a fall of 7% in net profit next year. Therefore, its shares may come under further pressure in the short run following their drop of 20% in the year-to-date.
However, Rio Tinto offers excellent long term growth potential for those investors who believe that commodity prices will recover over the medium to long term. That’s because it trades on a price to book value (P/B) ratio of only 1.27 which, given the quality of its asset base, is highly appealing. Furthermore, it has a sound balance sheet, ultra-low cost base and very strong cash flow which appears to be adequate to make generous shareholder payouts as well as engage in sustaining capital expenditure in the coming years.
Similarly, buying a resources support service company such as Petrofac (LSE: PFC) also seems to make sense. Unlike Rio Tinto, Petrofac is expected to return to positive earnings growth next year, with its net profit due to rise by as much as 174% following the anticipated 70% fall in the current year. This puts Petrofac on a forward price to earnings (P/E) ratio of just 9.1 and, while there is scope for downgrades over the next year, the margin of safety on offer seems to be generous enough to warrant investment.
Furthermore, Petrofac has relatively strong earnings visibility as a result of 2014 being a record year for its backlog of orders. And, looking ahead, its focus on low cost operating regions in the Middle East and North Africa could allow it to perform relatively well even if a low oil price environment is maintained over the medium term.
Meanwhile, Lamprell (LSE: LAM) continues to benefit from improved efficiency and cost reduction measures. And, with over 90% of 2015 revenue and 60% of 2016 revenue being covered in its interim results, it appears to have a relatively bright short to medium term future as it remains on-track to post flat revenue in 2016.
As with Petrofac, Lamprell is expected to post positive earnings growth next year and, while growth of just 3% is hardly exceptional, it would represent a step in the right direction following what is set to be a disappointing 2015. With the company’s shares trading on a P/E ratio of only 10.3, there is upward rerating potential and, with its current projects progressing well, it seems to be a sound long term buy.
