With global growth slowing further in April, and the market increasingly recognizing that the Chinese slowdown is structural, many commodity prices will probably remain under pressure as we complete the traditionally volatile month of May. Year to date, iron ore prices are down by 8%. What should you do if you hold any of the following popular producers in your portfolio?
Management’s efforts are playing a big role in the Brazilian mining champion Vale SA (ADR) (NYSE:VALE). First quarter EPS came at $0.60 from the loss of $0.52 in the last quarter of 2012. EBITDA came up 18% quarter over quarter and 55% up year over year with EBITDA margin increasing from 36% to 48% quarter over quarter thanks to consolidated selling, general and administration expenses decreasing to 3% of net revenues, and second, base metals margin improvement to 41% from 10% in the fourth quarter.
Vale SA (ADR) (NYSE:VALE) is cutting costs efficiently and maintaining its low leverage with net debt to EBITDA at 1.3. Meanwhile, capital expenditures were in line with management’s guidance and the company is on track to deliver by 2014 the expansion of Carajas Norte, Conceicao Itabiritos and Vargem Grande, projects which should drive the company’s growth in net iron ore volume in 2014. Overall, trading at a 2013 5.5 EV/EBITDA (below global peers), Vale SA (ADR) (NYSE:VALE) is the clear buy within the global large cap miners.
Rio Tinto plc (ADR) (NYSE:RIO) is facing problems
Rio Tinto plc (ADR) (NYSE:RIO) is under attack from many angles. At the macro level, weak Chinese growth data and fears of a global slowdown are reducing iron ore prices. At the company level, lower copper production and one-off costs as a result of the Kennecott Copper mine slip (a slide occurred in the northern section of the pit and around 150 meters of waste material slipped from the north wall of the mine into the pit area blocking the mine) are complicating the company’s free cash flow.
Even if a better than expected outcome would result from the various company specific issues, an improved macro outlook is essential for Rio Tinto plc (ADR) (NYSE:RIO) to outperform the market. While Rio Tinto plc (ADR) (NYSE:RIO) offers the best exposure to global iron ore markets, fears of overwhelming market volume growth and a near-term expectation of a slowdown in Chinese steel production are set to put pressure on prices. That said, through its 50% volume increase, I expect Rio Tinto plc (ADR) (NYSE:RIO) to consolidate iron ore market share. This could help offset lower prices.
The way I see it, only the finalization of any of the various asset sales (that I expect to fetch $10 to $12 billion), could help Rio Tinto plc (ADR) (NYSE:RIO)shares going forward. Trading at a 2013 5.6 EV/EBITDA it is tough not to see Rio Tinto as an opportunity. Nevertheless, the company’s specif issues are too many. I would stay on the side lines.
BHP Billiton Limited (ADR) (NYSE:BHP): Quality comes at a price
Iron ore and petroleum account for the majority of BHP Billiton Limited (ADR) (NYSE:BHP)’s production growth from 2013 to 2018. As iron ore prices are expected to be soft going forward, EBIT margins should moderate from a high 63% in 2012 to a still very high 47%. Petroleum accounts for 41% of forecast capital expenditures to 2018 and the majority of this is expected to go to onshore activities. That said, petroleum EBIT margins are forecast to decline from 47% to 37%.
Apart from macro and commodity price trends (soft iron ore prices), company specific catalysts include potential project approvals after August: Spence and Cannington Base Metals projects, and the Greenfield Jansen potash project. Those projects should be prioritized to still allow for an overall declining capital expenditures profile (from the guided $22 billion this year) and moderating debt level. Conversely, asset sales are also on the table with speculation that many of its non-core assets could be up for grabs.
Trading at a 2013 7 EV/EBITDA, BHP Billiton Limited (ADR) (NYSE:BHP) is considerably more expensive than the two peers named above. That said, the group is more diversified out from metals. Nevertheless, I would not go long BHP Billiton Limited (ADR) (NYSE:BHP) at the current level.
Bottom line
Despite its lower cash dividend yield (at 2.4% versus 3.5%), out of the three companies named above, I would only go long Vale SA (ADR) (NYSE:VALE). While Rio Tinto has too many company-specific issues, BHP Billiton Limited (ADR) (NYSE:BHP) seems to expensive for its risk profile. Of course all three companies are great enterprises and cash flow generators. As a matter of fact, they pay fair dividend yields while they sustain their capital expenditure needs without pushing debt too high.
The article Iron Ore: The Market and Main Players originally appeared on Fool.com and is written by Federico Zaldua.
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