The future path of commodity prices is almost impossible to predict. On the one hand, there’s a glut of supply at the moment that’s showing little sign of changing in the near term. However, in the long run the reductions in exploration spend and in adding production capacity that are taking place across the resources industry could lead to a fall in supply.
And with demand for commodities such as oil and platinum likely to rise over the medium-to-long term, commodity prices may remain volatile, but could rise in the coming years.
Good time to buy?
However, companies such as Premier Oil (LSE: PMO) are preparing for a sustained period of low prices. It has made significant progress in reducing its cost base and in becoming more efficient to improve its financial outlook. Furthermore, it has used the current low ebb in oil prices to invest for its long-term growth via the purchase of Eon’s North Sea assets. This has improved Premier Oil’s asset base quality and could act as a positive catalyst on its bottom line.
Premier Oil currently trades on a price-to-book (P/B) ratio of only 0.6. While further asset writedowns can’t be ruled out, this low valuation indicates that Premier Oil has at least 30% upside potential. Even if its shares rose by such an amount, they would still trade well below net asset value, which indicates that now is a good time to buy them.
Value for money
Similarly, Anglo American (LSE: AAL) has made major changes in its business model in response to falling commodity prices. It has made multiple asset disposals which, alongside a reorganisation of the business, have helped to make it more streamlined and more efficient. It has also suspended dividends and while this disappointed income investors, it’s likely to make the business healthier and it could lead to an improved long-term outlook.
In terms of its near-term forecasts, Anglo American is expected to report a fall in earnings of 5% in the current year. However, this is due to be reversed next year with growth of 14%. This puts Anglo American on a price-to-earnings growth (PEG) ratio of 1.2, which indicates that its shares offer good value for money, as well as over 30% upside.
Investor sentiment
Meanwhile, Lonmin (LSE: LMI) has performed exceptionally well in 2016. Its shares are up by 190% since the turn of the year and over 30% gains are still on the cards. Lonmin has made major progress with its transformation plan, which has seen its business become increasingly efficient and with it having raised funds last year, it’s in a sufficiently strong financial position to make major changes in a short space of time.
Clearly, Lonmin has benefitted from an improved outlook for commodity prices in 2016. But with its pre-tax profit forecast to move from a £31m loss in the current year to a profit of £13m next year, investor sentiment in Lonmin could continue to improve. It trades on a P/B ratio of 0.6, which indicates that a further 30% upside is highly realistic.
