Rio Tinto (LSE: RIO), Glencore (LSE: GLEN) and Anglo American are flat year-to-date, but BHP Billiton (LSE: BLT) has risen 14.4%, and its performance is in line with that of more defensive companies such as British American Tobacco (LSE: BATS) (+13%) and Imperial Tobacco (LSE: IMT) (+17%).
All that glitters is not gold. Here’s why.
Is It Time To Bet On a Rally For Miners?
BHP Billiton seems to be the outlier in a sector that has been under enormous pressure since the second half of 2014. Only in recent times, however, have its shares roared back, and that came in the wake of upbeat results in February for the half year to 31 December 2014, which showed higher operating profits in iron ore and copper, as production costs remained low.
While deep cost cuts are in order, BHP is cutting back on capital expenditures and its growth prospects are not appealing — it’s nothing usual for miners these days. But operating margins may deteriorate at a faster clip in the next few quarters on the back of declining revenues, and even though BHP’s debt pile is under control, there is a real risk that its dividend policy may come under scrutiny if weakness in commodity prices persists. Finally, it can easily be argued that without large buybacks, its shares won’t surge.
Trading Multiples & Yields On Their Way Down?
Anglo American, Glencore and Rio Tinto trade at a significant discount to BHP based on their forward price-to-earnings (p/e) multiples, but in most cases the valuation gap isn’t meaningful based on adjusted operating cash flow multiples, which suggests BHP stock has just caught up with its rivals in recent weeks.
Rio Tinto is similarly troubled with regard to strategy, while Glencore seems to be better placed, both financially and operationally, to cope with persistent downwards pressure on commodity prices.
Meanwhile, Anglo American remains an appealing takeover target, although it may be hard to engineer a big takeover right now for Glencore and BHP, the two most likely suitors. “The stock is back to 2013 lows… vs the sector,” Royal Bank Of Canada also pointed out on Monday.
The forward yield of these miners ranges between 4% and 5%, and although debt reduction is on the cards across the sector, dividends could be at risk. “The price of iron-ore shipped to China fell 4.5% late Thursday, to $59.30 a metric ton, according to data provider The Steel Index. That was the lowest level since March 2009, when it hit $59.10 a ton,” Dow Jones reported at the end of last week. This would almost certainly please Glencore’s management, who have repeatedly questioned the strategy put in place by BHP and Rio since the end end of 2014.
Tobacco Premium
Imperial Tobacco and British American Tobacco trade at a 24% premium to BHP, based on forward p/e multiples (the premium is much higher based on forward cash flow multiples). Both look fully valued, but they looked fully valued last summer, too, and have recorded a terrific performance since.
The capital gains these two tobacco makers have delivered in the last nine months have really surprised me, and although the shares of Imperial Tobacco in particular look very expensive, investors will likely continue to pay up for Imperial Tobacco and British American Tobacco in the current environment, in my view: investors do not seem to be concerned about regulatory issues and a fast-moving trading environment for tobacco makers, which are faced with changing preferences by the consumer.
Nomura cut the stock price target of British America Tobacco — down to a level in line with its its current valuation — at the end of last week, and while I think more downgrades from analysts could put pressure on tobacco stocks in months ahead, there remains a chance that volatility comes back with a vengeance: then, Imperial Tobacco and British American Tobacco will be two stocks you will want to hold as part of a diversified portfolio, and not only for a forward yield above 4%.
