Watch These 3 Resource Stocks with High Bearishness

02/05/2015 7:00 am EST

Focus: STOCKS

Chris Lau, of Kapitall.com, charts a trio of resource stocks in the energy sector that have been hit hard, but are still worth watching as turnaround prospects given their high bearishness.

Resource stocks have been hit hard, but it's worth looking out for a turnaround in these three with high bearishness.

Few investors should be surprised that bearishness is high for stocks in the energy and materials sector. Of the S&P 1500, 35 stocks have a short free-float of more than 25%. Negativity in these sectors is justifiable: energy prices may have yet to find a bottom and demand is weakening for other commodities. The situation creates an opportunity for investors eyeing a reversal.

Of course no one can precisely predict the turnaround in commodity prices. Until demand improves, the downside may continue. Still, there are three companies investors should look at.

Cliffs Natural Resources (CLF)

Closing as low as $6.11 on January 29, short interest for Cliffs is 49.3% of float. The iron ore firm is facing a number of challenges. First, weak iron ore prices forced it to eliminate its dividend. Second, its debt is too high and will weigh on its balance sheet so long as the firm operates at a loss. That said, Cliffs did manage to lower its debt balance by over $400 million during the fourth quarter of 2014.

Cliffs may turn the corner as it sheds unprofitable assets. If iron ore prices stabilize, the firm will be in a better position to generate profits again.

Transocean Ltd. (RIG)

Short interest versus float for Transocean is 32.49%. Closing as low as $15.21 on January 15, the stock's dividend is $3 per share, which yields 18.4%. At such a high yield, the stock is priced for elimination of its dividend. Since Transocean has plenty of assets it may sell and rigs it may shut down, the firm is more likely to maintain a dividend program. This will mean it keeps its income investors happy as it waits out the low day rates for deep water drilling.

Diamond Offshore (DO)

Diamond Offshore has a short interest versus float of 28.63%. Investors might be concerned that customers will cancel their drilling contracts. The fear is not fully warranted, because such cancellations would entail a fee for customers.

Diamond Offshore's balance sheet is healthier than competitors like Seadrill (SDRL). For example, DO's debt to equity ratio is 0.50, compared to 1.33 for Seadrill. The reason is simple: DO did not overspend when drill rates were higher. This gives the firm room to build its fleet of drills in the months ahead.

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By Chris Lau of Kapitall.com

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