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Reporting season preview – resources companies

Resource company reports are likely to be heavily scrutinised this earnings season to see whether the mining boom has peaked and whether there’s any positive signs for the year ahead.

Falling commodity prices are likely to be the number one reason for companies reporting falling revenues. Iron ore miners like Rio Tinto Limited (ASX: RIO) and Fortescue Metals Group (ASX: FMG) may offset falling prices by increasing production volumes. Some of the other factors to watch out for, when you are looking at company reports this earnings season, are listed below.

Cash costs per unit of production, compared to the commodity price – This is used to determine the operating margin and the company’s relative performance to the industry and its competitors. As an example, with the gold price around US$1600 an ounce, obviously gold miners need to keep their cash cost of production below that level. Resources companies also have their administration and other expenses to add to the cash costs, so the lower the cash cost, compared to the commodity price, the better.

Production growth – Has increased production led to an increase in earnings, or are revenues still falling? Fortescue has plans to ramp up production of iron ore to 155 million tonnes within the next couple of years, and we’d like to know how much production grew last year. We can also compare it to revenue growth to get an idea of how lower commodity prices have affected the company’s performance.

Size of resource base – Does the company have enough resources to keep producing in the year or years ahead? It’s not much good if the company has low production costs, high margins and plenty of cash, if it doesn’t have enough resources to stay in business for the next year at least.

Have any new projects come on stream in the previous year? New projects are like new stores for retailers, they can ramp up revenues, and if close to other projects can reduce costs of shipment and processing.

Cash/debt position – If the company has a net cash position, all the better, as bankers are unlikely to come calling if the company struggles to meet its debt and interest payments.

Expansion plans – as we’ve seen the big miners shy away from investing in their mega-projects, like BHP Billiton Limited’s (ASX: BHP)  $20 billion expansion of its Olympic Dam project, during tough times, we’d like to see miners horde their cash, limit their debt and generally take a conservative view. Debt fuelled expansion, especially during weak economic times, has led to the failure of many companies.

Diversification/concentration by resource – like an investment portfolio, diversification can be good for businesses too. Fortescue and Atlas Iron Limited (ASX: AGO) are purely exposed to iron ore, whereas BHP receives large revenues from oil, gas, copper and other resources besides iron ore. Concentration can pay off big if you make the right bets, but it can also be the riskier path.

Outlook – This is a vital factor for resources companies, (like every other company). Does the company provide a guide for the year ahead? Usually resources companies will give an estimated range for their production in the coming year.

The Foolish bottom line

The overall themes from the miners’ results will play an important role in the outlook for mining services companies too. If you want to read the introduction to this series, plus find other sector previews, click here.

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Motley Fool writer/analyst Mike King owns shares in BHP. The Motley Fool‘s purpose is to help the world invest, better. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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