2015 has been a very challenging year for investors in the mining sector, with the UK’s two most prominent mining companies, Rio Tinto (LSE: RIO) (NYSE: RIO.US) and BHP Billiton (LSE: BLT) (NYSE: BBL.US), seeing their share prices fall by 8% and 4% respectively since the turn of the year. And, in the short term at least, their outlooks appear to be somewhat downbeat, with volatile profitability and weak investor sentiment unlikely to change over the coming months.
However, for long term investors, there is a tremendous opportunity to buy two high-quality stocks at distressed prices. And, if you can only buy one or the other right now, here’s why I think Rio Tinto is the preferred option.
Growth Potential
As mentioned, the bottom lines of both companies are very uncertain at the present time, with lower commodity prices having a hugely negative impact on both Rio Tinto’s and BPH’s profitability. For example, Rio Tinto is expected to see its earnings fall by 48% this year, while for BHP the figure is 44%. As such, investor sentiment has declined during the course of 2015.
However, looking ahead to next year, Rio Tinto is expected to return to growth, with a 20% rise in its net profit being forecast, while BHP’s earnings are set to fall by a further 27% next financial year. And, while the outlook for the mining sector may remain rather downbeat, earnings growth of 20% in just one year could act as a positive catalyst on Rio Tinto’s share price.
Bid Potential
While the Australian government has stated that it is likely to block a takeover for Rio Tinto, a bid approach could still be possible. For example, a potential suitor could agree to divest parts of the Rio Tinto business (or of its own business) in order to satisfy regulatory concerns. As such, a bid for Rio Tinto remains a possibility, with Glencore apparently being the most likely buyer.
This means that Rio Tinto’s share price could gain a boost from bid rumours over the medium term, while such an event seems less likely for BHP. That’s because it is hugely diversified and may be more challenging to integrate into an existing business. Furthermore, it is going through a period of intense change, with the recent spin-off of non-core assets demonstrating that BHP is arguably a less stable company than Rio Tinto at the present time.
Valuation
Looking at the two companies in terms of valuation, Rio Tinto appears to be the better buy. That’s because it trades on a forward price to earnings (P/E) ratio of 13.5 versus 20.2 for BHP. As such, there appears to be more scope for an upward rerating for Rio Tinto over the medium term – especially since it is set to post positive earnings growth from 2016 and could also be the subject of a takeover approach.
So, while BHP remains a stock that is very much worth buying at the present time, Rio Tinto appears to be the preferred option if you can only add one mining play to your portfolio right now.
