Tuesday, January 20, 2015

Stick with 'super miners'

David DittmanA deterioration of global macroeconomic sentiment, the threat of weaker commodity prices, unfavorable weather, the impact of past management missteps and shakeups in top leadership have hurt BHP Billiton Ltd. (BHP) and Rio Tinto Ltd. (RIO) .

Nevertheless, these stocks remain in the aggressive holdings section of our model portfolio. In our view, these super miners are beaten, but not broken.

BHP's American Depositary Receipt, which is listed on the New York Stock Exchange and represents two Australian stock exchange-listed shares, is off 18.17 percent in price-only terms, with a total return of negative 16.91 percent.

Rio's NYSE-listed ADR, which represents one share of the company's London Stock Exchange listing, is off 21.94 percent including dividends, 23.31 percent based on its price decline.

Prices for iron ore, the key driver of profits for both BHP and, to an even greater extent, Rio, peaked at USD158.90 per ton  in February, up 80 percent from September 2012 near-term lows, but by March 14, 2013, had declined to USD144.10 per ton.

And metals and minerals data and research firm Roskill Information Services forecasts that prices will drop to below USD100, possibly south of USD90, as global output rises.

Although these levels forecast by Roskill point to an ominous future for BHP's and Rio's iron ore operations, these companies -- with large-scale, low-cost projects -- will be in good position to satisfy demand as smaller, less diversified miners struggle to make the economics work.

Base metals, including copper, account for approximately 19 percent of BHP's earnings, while Rio's Oyu Tolgoi copper-gold mine is one of its primary growth projects. But petroleum has surpassed base metals to rank second to iron ore for BHP, and iron ore makes up more than 80 percent of Rio's profit.

BHP and Rio both combine sufficient diversification with unbeatable scale in packages that suggest they'll be able to overcome short- and medium-term economic and commodity-price turbulence.

It's hard to point to any clear catalyst that will energize BHP's and Rio's share prices. But long-term production growth is assured, their respective scale allows them to limit costs in ways other miners simply can't match and their streamlining asset bases will remain chock-full of "tier-one" projects.

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In addition, recognition by boards of directors at both behemoths of serious misallocations of capital resources in recent years has resulted in the appointment of new CEOs, as Andrew MacKenzie has replaced Marius Kloppers in charge of BHP and Sam Walsh is in for Tom Albanese at Rio.

Both new honchos have committed to more discipline when it comes to new projects as well as to finding cost savings at existing ones. The prospect of scaled-back capital expenditures holds out the potential for rising free cash flow, and that means dividend increases and/or share buybacks.

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