While many investors are understandably concerned about the prospects for the resources sector, now could be a great time to add high-quality miners and oil plays to your portfolio. Certainly, the global supply/demand imbalance is showing little sign of abating and, with iron ore near to a ten-year low and oil slipping back below $50 per barrel, the short-term prospects for the sector seem to be rather dire.
However, for long term investors who can cope with a degree of uncertainty, volatility and concern among the wider investment crowd, the margins of safety on offer appear to be more than sufficient to warrant investment. For example, Rio Tinto Limited (ASX: RIO) is forecast to turn its hugely disappointing performance around next year, with its bottom line set to rise by around 22% as its strategy of cutting costs, improving efficiencies and, crucially, increasing supply, takes hold.
This high rate of growth should allow the iron ore-focused miner to increase dividends per share by around 5.3% per annum during the next two years and, looking ahead, the company remains a viable income play. Not only does it offer a yield of 5.2%, it is also expected to cover dividends 1.4 times by net profit next year. And, with the Chinese economy expected to benefit from additional stimulus over the medium to long term, Rio Tinto's strategy of increasing its market share through growth in supply should enable it to post impressive levels of profit growth over the medium term.
Meanwhile, Oil Search Limited (ASX: OSH) is set to continue to benefit from its increased exposure to the liquefied natural gas (LNG) market via the ramp up in production from the Papua New Guinea LNG project, in which Oil Search is a partner. In fact, just this week Oil Search reported a 7% rise in its production for the three months to the end of June (versus the previous three months). And, looking ahead, the company is expected to post a rise in net profit of around 14% in each of the next two years. This puts its shares on a price to earnings growth (PEG) ratio of 1.42, since their value has fallen by 26% in the last year alone.
Of course, a fall in the price of iron ore or oil would be likely to cause a downgrade in the outlook for both Rio Tinto and Oil Search. However, with Rio Tinto having a price to earnings (P/E) ratio of 12.9 and, as mentioned, Oil Search having an appealing PEG ratio, further challenges in the short run appear to be adequately priced in.
Moreover, with both companies increasing cash flow per share at a brisk pace in the last ten years (6.2% per annum for Rio Tinto and 7.2% per annum for Oil Search), they have sound track records of improving financial performance so that even if the short run continues to be tough, they look set to be top performers in the medium term.
