Tuesday, April 16, 2013

Should I Buy Rio Tinto or BHP Billiton?

LONDON -- After making strong gains toward the end of last year, shares in miners Rio Tinto  (LSE: RIO  ) (NYSE: RIO  ) and BHP Billiton  (LSE: BLT  ) (NYSE: BBL  ) have fallen by around 10% since the beginning of 2013.

The falls have been caused by institutional shareholders trimming their holdings in each company -- but I believe this is a great opportunity to buy into these two world-class companies at very attractive prices.

Rio Tinto vs. BHP Billiton
'm going to start with a look at a few key statistics that can be used to provide a quick comparison of these two companies, based on their last published results:

Value

Rio Tinto

BHP Billiton

2012 revenue

£33,529

£44,043

P/E ratio

9.5

11.9

Dividend yield

3.5%

3.9%

Net gearing

41%

45%

Both Rio and BHP made paper losses last year, after writing down the value of several major assets. The P/E ratios I've included in the table above are based on underlying earnings, which I think provides a more realistic view of each company's performance.

The income available from both companies is also attractive -- both dividend yields are above the FTSE 100 average of 3.2%, making them worth considering for a diversified portfolio of income shares.

I expect Rio's and BHP's dividends to continue to grow over the next few years, as both companies have said they will cut back capital expenditure on new projects, and focus on maximizing their profitability and enhancing shareholder returns.

What's next?
Analysts' forecasts are notoriously unreliable, but FTSE 100 companies generally get the benefit of the most comprehensive analysis, and tend to deliver fewer surprises than smaller companies.

With that in mind, let's take a look at the forecasts for Rio Tinto and BHP Billiton. These apply to the companies' current financial years, which end in June (BHP) and December (Rio):

 

Rio Tinto

BHP Billiton

Forecast P/E ratio

7.2

11.3

Forecast dividend yield

3.7%

4%

Forecast dividend growth

6.3%

5.2%

Forecast earnings growth

26%

(32.0)%

These figures, which are based on the companies' guidance figures and analysts' forecasts, suggest that Rio may be nearer the end of its consolidation phase than BHP, which is expected to deliver another year of disappointing earnings.

It's worth taking a brief look at the main commodities produced by each company. Around 75% of Rio's earnings come from iron ore, while the remainder is split between aluminum, copper and coal.

In BHP's case, around 50% of earnings from iron ore, while around 25% comes from oil and gas production, mostly in the U.S. The remainder comes mostly from copper, aluminum and coal.

Which share should I buy?
BHP's major commitment to oil and gas is something to consider if you want a diversified portfolio, as it could take you overweight on oil if you also hold shares in a supermajor like BP or Royal Dutch Shell.

On the other hand, BHP does offer exposure to all the major industrial commodities in one share, which may be attractive, depending on your requirements.

I prefer Rio's focus on mining, rather than petroleum, and I like its growing emphasis on copper. For all of these reasons, Rio is my pick as a buy -- but I believe that both companies represent good value for money and provide an attractive way of earning an income from commodities.

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