Commodity prices have been hammered for the last few years and resource companies have endured a long bear market. Investors around the world are now wondering if we have seen the bottom in the commodity "super cycle", or if there is further pain to come. There will be huge amounts of money to be made if the bottom is correctly picked but it's a risky trade.
I think the following three companies should fly if commodity prices recover and today I'm investigating which is the best buy.
Premier Oil (LSE: PMO) has been one of London's best performing stocks this year and is up over 270% since lows in January. The company announced a covenant accretive acquisition of E.ON's North Sea assets and investors received the news well. Naturally the share price has ticked up with the oil price, but Premier has some problems to overcome in the second half of the year. The company is aiming to produce 65-70 kboepd (thousand barrels of oil equivalent per day) by the end of 2016 with the new Solan field boosting production.
Operationally the company seem to have increased production and lowered costs. The balance sheet is where the red flags appear and there is a chance Premier will breach banking covenants by the end of 2016. The company has $750m of liquidity at the moment and is already in negotiations with lenders which is encouraging. If some agreement can be made with lenders then Premier looks set to outperform.
Kaz Minerals (LSE: KAZ) is a copper miner focused in Kazakhstan. The location of the mine is perfect for transport into China for sale. The problem is that Chinese demand for copper isn't growing as expected and due to this the price for copper has crashed over the last 5 years. The company also has lots of debt on the balance sheet and net debt currently stands at $2.4bn.
Just like Premier, the company is in active discussions with lenders about covenants. If the copper price doesn't increase by a fair chunk this year then its a very real possibility that Kaz could breach debt covenants in 2016.
Vedanta Resources (LSE: VED) has interests in zinc, copper, iron ore and oil to name a few. The company is obviously highly geared to commodity prices and this was seen in its 2016 results. Revenue fell by over $2bn to $10.7bn and EDITDA fell by over $1.3bn to $2.3bn. This was accompanied by downgrade of Vedanta's ratings by Moody's and Standard & Poor's which meant covenants had to be renegotiated.
After a small reduction, net debt now stands at $7.3bn but gearing is a whopping 52%. The company needs commodity prices to significantly increase in the next year to return to profitability and reduce the gearing ratio. I believe this will happen but possibly not to the extent that Vedanta need to become a worthy investment.
Overall, I think all three of these companies have big challenges ahead but Premier Oil seems the most likely to survive. Premier has a strong asset base and revenue will be boosted with new production from Solan. This should help negotiations with bankers and ensure that the company survives in its current form.
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Jack Dingwall has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.