Among the wreckage of the commodities sector there are almost certainly some bargains: screaming buys that could easily rise by 200% when trading conditions improve.
In this article I’ll look at three commodities stocks that have lost more than 80% of their value over the last year. Do Premier Oil (LSE: PMO), Lonmin (LSE: LMI) and Genel Energy (LSE: GENL) have the potential to deliver 200% gains?
Lonmin
Lonmin shareholders who chose not to take part in last year’s rights issue have been effectively wiped out. But the picture has changed considerably since then, in my view.
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One of the biggest influences on Lonmin’s profitability is the USD-South African Rand (ZAR) exchange rate. Lonmin sells its platinum group metals (PGM) in dollars, but most of its costs are in rand.
According to Lonmin’s accounts, the ZAR/USD exchange rate it received in 2013 averaged 9.24:1. The current market rate is 16.16:1. This means that Lonmin’s platinum sales are generating increasing amounts of local currency, which funds most costs.
The firm’s latest trading update reported an average PGM basket sale price of ZAR10,859/oz. The group is forecasting production costs of ZAR10,400/oz. for the current year.
These figures suggest to me that just a small increase in the price of platinum could return Lonmin to profitability. If this happens, I believe the shares could rise by as much as 200%, as the market would rerate the firm as a going concern.
Premier Oil
Premier has net debt of more than $2bn, and seems likely to breach its lending covenants if the price of oil remains low for too long.
In my view, this means that shares in Premier are equivalent to a bet on the price of oil. If you believe that oil will recover to perhaps $60 during the next 12 months, then Premier could be a buy. I’d expect the shares to rise by at least 100% in such a scenario.
If you’re more cautious and believe oil is unlikely to top $50 this year, then you might want to stay away from Premier. The firm could face serious financial problems if income from its hedging programme tails off before the price of oil starts to recover.
An emergency refinancing would probably protect Premier’s lenders, but would be likely to wipe out shareholders.
Genel Energy
Genel has two big attractions. Firstly, it has big, cheap assets. By my calculations, the firm’s 429m barrels of proven and probable reserves are currently priced at just $1.55 per barrel.
Secondly, this oil is incredibly cheap to produce. In its most recent trading statement, Genel said that its production costs are less than $2 per barrel and that it can break even with Brent crude at $20 per barrel. At current prices, Genel should be profitable.
The big risks are the political and commercial challenges involved in operating in Kurdistan. Although payments for oil exports appear to be getting more regular, there are no guarantees for the future.
Chairman Tony Hayward has always made it clear he believes Kurdistan’s big, cheap oil reserves will find a profitable route to market. I’m tempted to agree. Although patience may be required, I rate Genel as a strong buy with the potential to triple in price when the oil market starts to recover.
