With the resources sector having been a sea of red in recent months, the valuations of a number of oil and mining companies have come under severe pressure. In fact, falls of over 50% of share prices are not uncommon in the last year, with investor sentiment declining rapidly as the prices of various commodities have fallen.
Certainly, value investors may be very interested in low valuations, but the challenge lies in assessing which companies are unjustly cheap and which ones are cheap for good reason. In other words, are resources companies such as Gulf Keystone Petroleum (LSE: GKP), Polymetal (LSE: POLY) and Cape (LSE: CIU) value traps or screaming buys?
Cape
With Cape’s shares having fallen by 16% in the last year, its decline is relatively modest compared to some of its sector peers. That’s at least partly because the industrial services provider has been able to maintain growing profitability in the last two years, with 2015’s forecast of an 11% fall in earnings being rather mild versus its sector peers. And, with Cape being expected to deliver a decline in net profit of just 1% next year, it appears to be coping rather well during a period of cutbacks for the energy sector.
As a result, Cape’s price to earnings (P/E) ratio of 8.8 indicates that it offers excellent value for money. Furthermore, a yield of 6% which is covered 1.9 times by profit is not only high but reasonably sustainable. So, while Cape’s share price could realistically fall further in the coming months, for investors looking years ahead it appears to be an excellent buy.
Polymetal
Similarly, precious metals company Polymetal seems to be in a stronger position as a business than its 4% share price fall since the turn of the year suggests. Certainly, the outlook for the price of gold, silver and copper is rather downbeat, but Polymetal’s earnings are due to fall by just 5% this year before rising by 3% next year.
Clearly, neither of these figures is likely to positively catalyse investor sentiment in the company, but a rising gold price could do so. The world economy continues to offer a rather uncertain outlook and, with interest rates set to begin their rise within the next six months, the contraction of global monetary policy may cause a flight to a store of wealth in the form of gold. Therefore, with Polymetal having a P/E ratio of 12.4, its shares appear to be worth buying for the long term.
Gulf Keystone Petroleum
Gulf Keystone Petroleum also offers a wide margin of safety. Its shares trade on a price to book value (P/B) ratio of only 1.2 which, for a company with such an appealing asset base, appears to be very low. The problem, though, is that Gulf Keystone Petroleum may require an even wider margin of safety to make it a strong buy at the present time.
That’s because its finances continue to be in a rather precarious position. Certainly, the receipt of $13m a couple of weeks ago from the Kurdistan Regional Government (KRG) is a positive step which has led Gulf Keystone Petroleum to begin exporting its oil rather than selling it at a lower price on the domestic market. However, there is still little information on whether its debtors will be cleared, as well as uncertainty regarding regular payments. As such, a lower P/B ratio may be needed before investment in case of a placing being required over the medium term.