Shares in Rio Tinto (LSE: RIO) Genel Energy (LSE: GENL) and Ithaca Energy (LSE: IAE) have performed very badly in 2015, as the following table shows:
Company | YTD share price |
---|---|
Rio Tinto | -37% |
Ithaca Energy | -53% |
Genel Energy | -74% |
Ive chosen these firms because in better market conditions all three would be seen as high quality, low-cost operations, with good assets.
The problem is that commodity producers dont stop producing just because they are losing money. If they did, the markets for iron ore and oil would probably come back into balance pretty quickly. As things stand, we may have a longer wait.
In the meantime, I think its worth monitoring these stocks. Is now the time to consider buying into a falling market?
Rio Tinto
Rio is a stock I hold in my long-term income portfolio. Ive averaged down once this year and intend to do so again in the next few weeks. This should help me lock in a higher dividend yield on cost in years to come.
Im confident buying more Rio because the firm has some of the lowest iron ore production costs in the world. Although iron ore has now fallen below $50 per tonne, Rio is producing it at a cash cost of $16.20 per tonne. Profits are almost guaranteed, and Rio will be there to benefit when prices do eventually recover.
Although the prospective yield of 8% flags up the risk of a dividend cut, I believe that Rios strong cash flow and manageable debt mean that any cut would be quite modest. Im happy to accept this risk.
Genel Energy
Genels current enterprise value (market cap plus net debt) of 672m values the firms 429m barrels of proven and probable reserves at just $2.37 per barrel. Thats extremely cheap, especially as Genel also has very low production costs.
Its tempting to see Genel as an easy buy, at less than 200p.
My only concerns are the political and commercial risks of operating in Kurdistan. Although Genel has plenty of cash to tide it over, it is owed around $400m by the Kurdistan government for past oil sales. Theres also the risk that the ISIS conflict will extend into areas of Kurdistan thathave previously been safe.
I believe the Kurds will pay if they can but what if they cant? Genel is a riskier play than Rio, but I believe it could deliver a multi-bagging recovery when the price of oil starts to recover.
Ithaca Energy
Ithaca is one of the better small-cap North Sea firms, in my view. It was consistently profitable from 2009-2013 and is expected to report a profit for 2015 and 2016.
However, the firms lenders recently reduced the amount they were prepared to offer the firm through its reserve-based lending facility. Thats the result of the falling value of Ithacas 70m barrels of proven and probable reserves.
Although Ithaca stock currently trades at just 0.2 times its book value, the groups net debt means these shares arent as cheap as they seem. Ithacas enterprise value is around 600m($910m). This means that the groups reserves are valued at about $13 per barrel. Thats not especially cheap.
As with Genel, I believe Ithaca shares could easily double when the price of oil starts to rise. However, theres a real risk that things could get worse before they get better.
That’s why I believe it’s important to diversify your portfolio.
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Roland Head owns shares of Rio Tinto. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.