Is it time to consider buying into good quality oil and mining stocks with recovery potential?
In this article I’ll look at two companies — BHP Billiton (LSE: BLT) and Petrofac (LSE: PFC) — that City analysts believe are likely to report a significant rise in profits for the coming year.
BHP Billiton
One of growth investing legend Jim Slater’s tips for investing in turnarounds was that you should only buy when profits are expected to increase over the next year. BHP meets that requirement. Earnings are expected to hit a new low of $0.26 per share during the current year, before rising by 76% to $0.45 in 2016/17.
Although BHP stock still looks pricey, on a forecast P/E of about 21 for next year, I think the group should be quite well-positioned for any recovery. BHP’s balance sheet remains reasonably strong and the group has reduced operating costs and cut capital expenditure. Any rise in the price of oil, iron ore or copper should feed straight through to BHP’s profits.
One risk investors do need to accept is that BHP’s dividend may be cut. Current forecasts indicate that the miner will pay a total dividend of $0.85 per share this year. This gives a potential yield of 9.3% at the current share price of 635p.
Although BHP has been reluctant to cut the dividend, a reduction is now widely expected among City analysts and might not have much effect on the group’s share price.
There’s no doubt that BHP will recover from the current commodity slump. I don’t think there’s a big rush to buy, but at close to 600p I think the price is starting to look quite attractive. Indeed, on a three-to-five-year view, I think a 50% gain might be possible from here.
Petrofac
Oil services group Petrofac was an early casualty of the oil market crash. The firm’s shares peaked in 2012 and have fallen steadily ever since. However, I think we may be getting close to the bottom.
The latest consensus forecasts show that Petrofac’s earnings per share are expected to rise by nearly 200% in 2016, moving up from $0.45 per share to $1.32 per share.
The current share price of 765p gives Petrofac a 2016 forecast P/E of 8.6. Clearly the market is pricing-in the real risk that earnings will miss expectations in 2016. However, investors who are willing to take this risk could benefit from a potential 6% dividend yield while they wait for oil market conditions to improve.
Personally, I don’t have much doubt about Petrofac’s survival, but I do have a couple of concerns that might prevent me investing. Firstly, I suspect that even when the oil market recovers, services companies like Petrofac won’t enjoy the same pricing power they used to have. I’d expect profit margins to be much lower for the foreseeable future.
A second concern is that Petrofac’s net gearing of 94% is quite high. Net debt of $1,399m means that interest costs could be significant. If earnings fall below expectations, then repaying this debt could take longer than expected, putting pressure on dividends.
Although I think Petrofac is potentially attractive, I’m going to wait until this year’s results are published in February before making any further decisions.
