Judging by the performance of companies which are focused on the resources sector in recent months, it seems that many investors have lost faith with the sector. Certainly, there is the potential for further pain in the short run and the prices of commodities could come under further pressure. However, there is also the scope for huge rewards, too, and through buying stocks with favourable risk/reward ratios, long term capital gains could be highly enticing.
One company which has seen investor sentiment and profitability slide in recent years is Anglo American (LSE: AAL). Its bottom line is expected to fall by as much as 36% in 2016 and while it is a relatively well-diversified business, commodity price falls across the board mean that further declines in profitability are on the medium-term horizon.
However, with a new strategy that seeks to streamline Anglo American’s operations and, most importantly, cut costs by a significant amount, the company’s long term future could be sound. Furthermore, the market has adapted to the company’s declining profitability and it now trades on a price to earnings (P/E) ratio of just 10.7 using 2016’s drastically lower earnings figure.
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And while its assets are worth less than they once were and could be written down in future, a price to book (P/B) ratio of 0.3 indicates that for long term investors it could be a successful investment rather than a failure.
Similarly, support services company Petrofac (LSE: PFC) is also changing its strategy to cope with reduced demand, now that investment across the energy industry is in decline. Like Anglo American, Petrofac is seeking to become more efficient and with the company having an impressive pipeline of business, its financial performance could be better than the market currently anticipates.
Certainly, Petrofac’s share price has been volatile in recent months, but even before the current oil price crisis Petrofac was never the most stable of companies. Looking ahead, its beta of 1.4 indicates further volatility is on the horizon, while a forward P/E ratio of 8.5 indicates upward re-rating potential.
Meanwhile, Rare Earth Minerals (LSE: REM) has recorded a share price fall of 28% in the last six months, despite having made encouraging progress on its plans. For example, it has signed a deal with Tesla to supply the car manufacturer with lithium for its batteries, while positive news about drilling activities at its assets has also been released. And with the potential for rapid increases in demand for lithium, as the world shifts to cleaner energy, Rare Earth Minerals could be a strong performer.
Of course, with a number of other mining stocks already being profitable and offering low valuations, for most investors there may still be better opportunities elsewhere – especially if investor sentiment in the sector does continue to worsen.
