Suffice to say, 2014 has been a year to forget for investors in mining companies such as BHP Billiton (LSE: BLT) (NYSE: BBL.US), Rio Tinto (LSE: RIO) (NYSE: RIO.US) and Glencore (LSE: GLEN). Their share prices have fallen by 27%, 16% and 6% respectively as a result of a collapse in the price of a wide range of commodities and, as a result, investor sentiment has also declined considerably.
While in the short run things may get worse before they get better, I’m bullish on their performance for next year as a whole. Here’s why.
Margin Of Safety
There’s no hiding behind the fact that lower commodity prices mean lower profit for all mining companies. Unlike consumer goods and technology companies, they have next to no control over the price they receive for the commodities they mine and this means that their earnings are, by default, highly volatile and unpredictable.
So, with commodity prices having fallen, it is of little surprise for the earnings of BHP and Rio Tinto to fall and, as such, they are forecast to decrease by 21% and 12% respectively next year. As a result, their share prices rightly trade at a discount to the wider index in terms of their valuation. However, the scale of the discount appears to be overly generous, since BHP and Rio Tinto have price to earnings (P/E) ratios of just 10.6 and 9.2 respectively, while the FTSE 100’s P/E ratio is 14.9.
Therefore, even if commodity prices do fall further, this eventuality appears to be more than adequately priced in to the share prices of BHP Billiton and Rio Tinto. As such, any stabilisation or increase in the price of iron ore, for instance (which is a major contributor to both companies’ revenue streams), could cause a substantial narrowing of the current valuation gap versus the wider index.
It’s a similar story with regards to Glencore. Although its bottom line is forecast to be 2% lower this year, it is expected to rise by 31% next year. This is an impressive rate of growth and, despite this, shares in Glencore trade on a P/E ratio of 14.2, which equates to a price to earnings growth (PEG) ratio of just 0.5. This indicates that growth is on offer at a very reasonable price and could mean a share price rise is on the cards for next year.
While commodity price falls are bad news for short term profitability, the size and scale of BHP, Rio Tinto and Glencore means that their cost curves tend to be lower than many of their smaller rivals. This can mean an increase in market share during lower pricing periods and, in the long run, can equate to a strengthening of their positions in various commodity markets, thereby leading to greater profitability.
In addition, with their valuations being so low, it could give rise to sector consolidation. A Glencore bid for Rio Tinto has been mooted for some time, but there could be other M&A rumours and activity to come during 2015, which could stimulate investor sentiment in the stocks.
However, it is mostly as a result of the considerable margins of safety that are currently on offer through BHP, Rio Tinto and Glencore that I’m bullish on their share price prospects for 2015. It could be a stunning year for investors in all three companies.