Why I'm Ready To Buy A Miner

Published in Investing on 14 June 2012

BHP Billiton and Rio Tinto are now two of the cheapest companies in the FTSE 100.

One sector that I've been reluctant to invest in over the last few years is big miners -- giants like BHP Billiton (LSE: BLT), Rio Tinto (LSE: RIO) and Anglo American (LSE: AAL).

These behemoths of the resource industry have been supremely profitable but a little expensive for my taste, thanks to booming global demand for their commodities. However, slowing growth in China means that is all starting to change, and these shares are starting to show me two key buying signals.

Let me explain.

Thanks, China

China's growth rate has slowed slightly this year, causing widespread falls in the share prices of the world's biggest mining companies. Despite this, China's GDP is still expected to grow by about 7% this year -- and from a much larger base than in previous years.

This means that global demand for commodities like coal and iron ore will remain strong, but it does mean that the commodities industry is likely to move from flat-out expansion into a more mature, 'cash cow' phase.

The big miners seem to have anticipated this quite sensibly, with Rio and BHP both announcing scaled-back, more focused investment plans over the last few months.

I reckon this is good news, and will give investors who didn't get on board before the commodities boom got started a second chance to gain access to these companies' earnings at an attractive price.

Covet thy earnings

Earlier this year, the world's third-richest man, Warren Buffett, ignored market sentiment and increased his holding in one of the UK's biggest companies to more than 5%.

Buffett did this because he thought it looked cheap and he wanted greater access to its strong, long-term earnings (you can find out the name of the company Buffett bought and the price he paid in this free Fool report).

Buffett's logic is the reason I am currently so attracted to big mining shares; access to cheap, long-term earnings.

In 2011, BHP Billiton made operating profits of £19bn on turnover of £44bn. Most of the big mining projects BHP and its peers undertake have lifespans measured in decades, virtually guaranteeing a strong, reliable stream of earnings.

As the table below shows, access to mining companies' earnings has got a lot cheaper over the last year, falling much further than the FTSE 100 (UKX). This mouth-watering cheapness is my first buying signal:

CompanyPrice-to-earnings ratio12-month change
BHP Billiton7.1-23%
Anglo American6.6-27%
Rio Tinto5.5-31%
FTSE 10014.2-5.5%

Source: Digital Look, Yahoo! Finance

Here come the dividends!

My second buying signal is income. BHP, Rio and Anglo American are all expected to start paying out a greater share of their earnings in dividends over the next few years. As the table below shows, they all have a much higher level of dividend cover than the FTSE 100 average, and can easily afford to give shareholders a pay rise:

CompanyYieldDividend cover
BHP Billiton3.63%3.9
Rio Tinto3.25%5.6
Anglo American2.23%6.8
FTSE 1003.8%2.85

Source: Digital Look

These figures suggest to me that a 4%+ yield will soon be within the reach of shareholders in BHP and Rio, taking their yields above the average for the FTSE 100; one of my criteria for buying.

Indeed, as I write, BHP offers a 4.1% yield based on its current share price and forecast total dividend for the current financial year.

Ready to buy?

Shares in Rio and Anglo American have now fallen to 2006 levels and, while BHP remains a little more expensive, I believe that all three now offer very good value.

My choice will be BHP or Rio, probably the latter, but I've got a feeling they might all be cheaper still later this year, so I'm going to keep my powder dry for a little longer yet.

In the meantime, you might be interested to know that the Fool's own team of analysts have also singled out the mining sector as one of the best places to invest in 2012. You can find out which mining shares they are tipping in this free report, "Top Sectors Of 2012", which I highly recommend.

Where is the UK's leading dividend stock-picker investing today? The identities of Neil Woodford's favourite blue chips are revealed in this free Motley Fool report -- "8 Shares Held By Britain's Super Investor".

Further investment opportunities:

> Roland does not own any of the shares mentioned in this article.

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Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

ANuvver 14 Jun 2012 , 12:52pm

IMO too soon.

There is a problem in that dividend payouts in the mining sector are traditionally regarded as a sign of weakness. Perhaps the paradigm is about to shift, but that would potentially put a ceiling on forward dividend increases. Every company with any sense is hoarding cash at the moment, and cost-sensitive miners have more reason to do so than most. Just because they have scope to increase payouts doesn't mean payouts will happen. In fact, I would conjecture that a propos the companies' own share capital, share buybacks are more likely.

Oh, I'm watching them. But I'm also having regular consultations with Dr Copper, and he's not too happy right now.

sopavest 14 Jun 2012 , 2:01pm

@ANuvver,

I agree, I think it's a little too soon yet - but the time will have to come sooner or later.

Regarding dividends, I'm not expecting SSE-style payouts but RIO and BLT's yields don't need to rise by very much to become quite attractive. We will see...

Copper isn't a big deal for BHP but it is for Rio - possibly one reason Rio is so much cheaper at the moment?

Cheers, Roland (article author)

jongleur100 14 Jun 2012 , 4:03pm

It does seem a bit too early to buy in, despite low P/E- I'd set very tight stops if buying right now.
In terms of one-year, at 2810-2840p and 1762p respectively, both RIO and BLT look attractively priced now, just a few percent above their October 2011 dips. But let's not forget: in the 2008 crash RIO dipped to 1049 and BLT dipped to 798p. If Greece+Spain+Italy adds up to euro-default and China weakens, we could be back to FTSE at 4000 and the same old scenario for miners/commodities. That'd be a 61% drop for RIO and a 55% drop for BLT.
And who's to say the recovery would be as unnaturally rapid and steep as it was in 2009?
For me the joker is China - that's the main current raw materials demand, and we have no idea of knowing what is going on there. We just know they have a hell of a housing bubble, and that Anthony Bolton has burnt his fingers there yet again. I like visible accounts.
As ANuvver says, miners are not exactly reliable divi providers over time. (If [s]he were following Uncle Ben, surely a Jan 2009 RIO buyer for example would have sold above 4000 in 2010/11 and taken the 170% profit? :-)

Kingfisher55 18 Jun 2012 , 2:22pm
retire1asap 18 Jun 2012 , 5:18pm

What's the opinion on using an ETF to get into the mining sector? e.g.

db x-trackers Stoxx® Europe 600 Basic Resources ETF

Rio Tinto plc
23.95%
BHP Billiton plc
15.40%
Anglo American Plc
14.43%
XStrata plc
12.04%
ArcelorMittal S.A.
5.15%
Tenaris S.A.
2.87%
Glencore International plc ORD USD 0.01
2.64%
Randgold Resources Ltd
2.63%
Antofagasta plc
2.41%
UPM-Kymmene Oyj
2.18%

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