Can BHP Billiton Plc And Rio Tinto Plc Survive A China Slowdown And The End Of QE?

Harvey Jones asks whether BHP Billiton plc (LON: BLT) and Rio Tinto plc (LON: RIO) are in double trouble.

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2013 has been a year of disaster for mining stocks. After peaking at £22.36 in mid-February, BHP Billiton (LSE: BLT) (NYSE: BBL.US) has plunged 16% to £18.76, while Rio Tinto (LSE: RIO) (NYSE: RIO.US) has fallen 23% to £29.03. It isn’t hard to see why. Commodity prices have been driven by the China growth story and quantitative easing (QE), now both under threat. Can these stocks survive the subsequent squeeze?

Over the last two years, BHP Billiton has fallen 21% and Rio Tinto is down 34%, against a 12% rise for the FTSE 100. Five-year share price growth has also been pretty rocky, especially for Rio. China has been looming over mining stocks for some time now. Official figures  still put Chinese GDP growth at 7.5% a year, but the true figure is likely to be much lower, despite the massive credit bubble of the past few years. So that is one slab of risk looming over the industry.

Screaming buy

The other is the end of QE. When US Federal Reserve chairman Ben Bernanke suggested tapering QE, markets screamed their little heads off, and mining stocks fell 20% in a couple of months. When he backed off, they recovered as quickly as a spoiled child whose bag of sweets has just been returned. Bernanke isn’t going to risk his eardrums for a while, but mining investors must brace themselves for another share-price screaming fit when he does.

That doesn’t destroy the investment case for BHP Billiton and Rio Tinto, because much of the danger is reflected in the price. BHP Billiton is available at nine times earnings, comfortably below the FTSE 100 average of 13.25 times. Rio Tinto is marginally cheaper, at 8.9 times earnings. BHP Billiton’s earnings per share (EPS) growth is expected to fall 30% in the year to 30 June 2013, but should rise a healthy 19% in the next 12 months. It’s a similar story with Rio. Forecast EPS growth is just 3% to 31 December 2013, followed by a healthy 17% next year.

Copper-bottomed yield

Given their cyclical nature, I like to buy mining stocks when they are down. I bought BHP Billiton a year or so ago, following a 25% share price drop of around 25%. It hasn’t gone anywhere since, but I haven’t lost money either. In the meantime, I have pocketed a yield of 3.9%, slightly higher than the FTSE 100 average of 3.46%. Rio, which I don’t hold, yields 3.7%. Both dividends are covered roughly three times and are forecast to rise higher, thanks to progressive dividend policies.

BHP Billiton has just posted a “strong” production report, with a 13th consecutive annual iron ore production record, and a 28% increase in copper production to 1.1 million tonnes, which offset drilling delays in the Gulf of Mexico. Management is wisely responding to current uncertainty by cutting capital spending and raising productivity. Rio has also just published strong production figures for iron ore and copper. Management says Rio is “well on track to meet its $750 million targeted reduction in exploration and evaluation spend in 2013, with spending in the first half down by $483 million”.

Iron men

It worries me that both miners are ratcheting up their iron ore and copper production at a time when demand may be dwindling. China worries me also. So does the end of QE. You missed a great chance to buy these companies a couple of months ago, yet BHP Billiton is still 17% below its 52-week high of £22.51, while Rio is 25% off its 52-week high of £38.38. Today still looks like a good time to load up on the miners, if you take a long-term view. If you prefer to drip money into the stocks, the rocky road to recovery should throw up several more opportunities.

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> Harvey holds shares in BHP Billiton. He doesn’t hold any other company mentioned in this article

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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