Investors have really turned their backs on Rio Tinto (LSE: RIO) (NYSE: RIO.US) and BHP Billiton (LSE: BLT) (NYSE: BBL.US) this month. Indeed, concerns about the state of the Chinese economy and falling price of iron ore are just two of the factors that have weighed on sentiment.
As a result, since the beginning of September Rio and BHP have underperformed the FTSE 100 by around 7% and 9% respectively. But is time for investors to sell up and move on before prices fall even further?
Iron ore troubles
The main reason behind Rio’s and BHP’s declines is the sliding price of iron ore, which has fallen by more than 40% year to date. As two of the world’s largest iron ore producers, Rio and BHP are defiantly going to take a hit from these declines.
In particular, as I’ve said before, City analysts have estimated that a $1 drop in the average iron ore price, wipes out $135m of annual net profit after tax at BHP Billiton and $122m at Rio. The price of iron or has fallen below $80 per tonne this week, down from around $130 per tonne at the beginning of the year, snatching billions in prospective profit from BHP and Rio.
Nevertheless, BHP and Rio are in a better position than most to weather the iron ore price storm. Rio has previously stated that it is able to produce iron ore at an average price of $21 per tonne. Meanwhile, analysts believe that BHP’s production breaks even at around $45 per tonne.
Additionally, BHP works around a ‘four pillars’ commodity strategy, which means that, although the company does have a large exposure to iron ore, it’s well diversified. Alongside iron ore, BHP’s other pillars include copper, coal and oil, there’s been some speculation that the company could also introduce a fifth pillar, potash.
Well placed
With BHP’s diversification there’s no need to dump the company’s shares just yet. Moreover, the group’s simplification, due to take place during the next year or so, will put BHP in a great position to drive growth and improve profitability over long-term.
BHP’s simplification will involve the spin-off of more than half of the group’s 41 assets worldwide. The remaining 19 assets were responsible for around 96% of BHP’s earnings before interest and tax during the 2014 financial year. So, the company’s earnings are not expected to fall significantly after the break up.
With two separate mining groups, each with a different focus, management teams will be able to spend more time overseeing the regions of the businesses that need the most attention.
What to do?
All in all, as BHP continues to restructure, investors shouldn’t jump ship just yet. Indeed, while BHP will suffer from the falling price of iron ore, the company has three other pillars which it can lean on.
Rio, on the other hand, is in a less advantageous position as the company is an iron ore producer through and through. However, with the industry’s lowest iron ore production costs, Rio isn’t going anywhere just yet and the shares are a great long-term investment.
