The last couple of years have been hugely challenging for the mining sector, with weak commodity prices leading to reduced profitability and weakening investor sentiment. While the recent past may be mirrored over the short-to-medium term, long term investors may wish to consider the purchase of mining companies thathave brighter outlooks. Thats because in some cases they offer a relatively wide margin of safety and trade on very appealing valuations.
Whilethings could realistically get worse before they get better for mining companies, that could mean buying companies thatoffer size, scale and profitability could be a shrewd move for investors. Thats because the larger mining companies may have the most appealing risk/reward ratios in terms of offering low prices and upward rerating potential, as well as a track record of profitability and relative financial soundness.
Going For Gold
Fresnillo (LSE: FRES) is among the largest silverproducers in the world andRandgold Resources (LSE: RRS) has the same statusamonggold producers. With their share prices having fallen by 62% and 28%, respectively, since the start of 2013, its clear that theyre trading at a low ebb. Thats no surprise after their huge falls in profitability, with Fresnillos earnings per share (EPS) declining by 93% in the last three years and Randgold Resources EPS being 47% down in just two years.
While these EPS figures are hugely disappointing, both companies have been able to stayin profit throughout the price falls in gold and silver. And looking ahead to the next two years, theyre expected to post excellent growth numbers. For example, Fresnillos bottom line is forecast to rise by 158% this year and by a further 84% next year. This puts it on a price-to-earnings-growth (PEG) ratio of just 0.4, which indicates a share price recovery is on the cards. And, with Randgolds earnings expected to rise by 22% next year, its PEG ratio of 1.1 is also highly appealing.
In The Slow Lane
Clearly, not all mining companies have the size, scale and production capabilities of Fresnillo and Randgold, which makes them a less appealing investment for now. TakeAfrican Potash (LSE: AFPO) and Beowulf Mining (LSE: BEM) that are a fraction of the size of their two sector peers. Many investors may be bullish on their long term prospects after their share prices have collapsed by 40% and 47%, respectively, since the start of 2013. Yet their appeal for most investors may prove to be limited.
Thats not necessarily because thoselong term prospects are disappointing, or that their strategies or management teams are poor. Its merely a reflectionof the current state of the mining sector that there are large-cap miners trading at exceptionally low prices and thatoffer the potential for growing profitability over the short-to-medium term. Furthermore, those large-cap firmsoffer greater diversity and financial strength than their smaller peers and, as such, appear to offer a more favourable risk/reward opportunity for the long term.
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