One of the challenges for investors at the present time is deciding whether or not to buy resources stocks. On the one hand, the price of oil and other commodities could realistically continue its downward spiral and cause further share price declines in companies operating within that space. Similarly, commodity prices could also soar in the months and years ahead, leaving investors who decided to sit on the sidelines feeling disappointed with their lack of action.
While it is hugely challenging (if not impossible) to decide where commodity prices will move to next, it is possible to seek out the companies within the sector that offer the most appealing risk/reward ratio. In other words, while the change in the oil price will affect the outlook for all oil companies, some businesses will be able to cope better than others and, in an era of low commodity prices, some companies will become more efficient than others. As such, choosing the right commodity stocks could be more important than many investors realise.
For example, BHP Billiton Limited (ASX: BHP) appears to be better able to cope with a period of low commodity prices than many of its peers. That's because it has a size and scale advantage over most of its rivals and this means that it should be able to work the situation to its own advantage and come out in a stronger position relative to its sector peers.
In this regard, BHP has already been making progress, with restructuring plans taking effect via the spin-off of non-core assets and the company increasing production so as to put further pressure on rivals which do not enjoy the same advantages in terms of a low cost base and vast efficiencies. Certainly, such activity may take time to have a major impact on its market share and bottom line, but BHP appears to be turning a disaster into an opportunity in terms of squeezing its rivals, which bodes well for its investors.
Similarly, Oil Search Limited (ASX: OSH) may be better able to cope with the current challenging conditions than many of its peers. For example, it is due to increase its earnings by 17.1% per annum during the next two years as it continues to benefit from a ramp-up in liquefied natural gas (LNG) production.
As with BHP, improving cash flow means that Oil Search is likely to enjoy stronger investor sentiment than many of its peers, since the market is increasingly focusing on a company's financial outlook so as to ensure that it can survive in a low oil price environment. On this front Oil Search has an excellent track record, with its cash flow per share having risen at an annualised rate of almost 25% during the last five years.
Furthermore, the two stocks are also priced to buy, with BHP's low valuation being evidenced by a dividend yield that even after a small reduction in shareholder payouts is expected to yield around 6.7%. Meanwhile, Oil Search has a price to earnings growth (PEG) ratio of 1 (versus 1.4 for the ASX) which indicates that, like BHP, there is plenty of scope for share price gains over the medium to long term.
