Why I Would Buy BP Plc Over Rio Tinto plc & Antofagasta plc As Commodities Tank

Here’s why this Fool would bet on BP PLC (LON:BP) rather than on Rio Tinto plc (LON:RIO) & Antofagasta plc (LON:ANTO).

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

High returns bring high risks — but what if I told you that high returns could be achieved by taking a calculated risk today? 

Take BP (LSE: BP), for instance: a company whose stock — falling 7.3% on Black Monday — trades between 30% and 80% below fair value, based on certain assumptions.

Yet if you are betting on a resurgence in commodity stocks such as those of Rio Tinto (LSE: RIO) and Antofagasta (LSE: ANTO), which are down 24% and 30%, respectively, this year — well, think again. 

Let’s take a look at the two miners before we move on to the value play of the year. 

Rio & Antofagasta: It’s A Matter Of Price Now!

Rio and Antofagasta are similarly troubled, although their core businesses are rather different. Antofagasta released its interim results today, which did not move the needle. 

I won’t bother you with their underlying operations, their global exposure and why their shareholders are in deep trouble — just consider that China is a problem that is being overstated by many observers, in my view. 

Here, the problem goes to the heart of valuation — indeed, the problem is the valuation of assets in the mining sector.

The “assets write-down cycle” — whereby certain assets must be either valued or sold below book value as market prices plunge — is going to bring diminished economic profits and low proceeds from divestments for some time. Anglo American‘s $300m fire-sale of its copper mines in Chile this week proves the point. 

Prices for copper have tumbled, so Antofagasta finds itself in a hard place — but its balance sheet is sound, given that it shows a net cash position. Its forward yield is just above 2%, and doesn’t signal much risk. The problem is that its shares trade on a price-to-earnings (P/E) multiple of 16, and that is not a valuation you’d like to pay for a commodity house these days. 

How about a more appealing target at 13x forward P/E, though? That’s where Rio’s stock trades, yet its forward dividend yield is north of 6%.

A Wrong Strategy Counts More Than A Sluggish Cycle

Just like BHP Billiton, Rio is paying the price of a wrong strategy in iron ore production. Its managers were blind, and couldn’t predict a challenging commodity cycle that eventually caught up with reality. Blame the legacy of the credit crunch — sluggish growth — for their woes!

I think UK investors overreacted yesterday, and it could soon be all over — the market may even forgive Rio. 

Operationally, however, its strategic decisions have been a disgrace. On top of that, the rejection of Glencore‘s approach last year was a disaster for both miners. Financially, then, it doesn’t look like its management team has considered all the options it has at its disposal to deliver value, either — it seems that investors believe Rio’s yield, which is covered, is too high and can’t be sustained.

The obvious advice? Chop it! Admittedly, its latest results were not too bad, but then its cash-burn rate wouldn’t let you sleep well at night if your name was on the shareholder register. 

BP Is A Steal At This Price

Oversupply is the oil industry is an issue that will be forgotten in less than a year, in my view. The Organization of the Petroleum Exporting Countries (OPEC) won’t sit idle for long, while the reading of US inventory data is less bearish than many suggest, although a decline didn’t materialise in recent days. 

Investors on Monday seemed to believe that the world was going to end pretty soon, and here’s the common thinking: commodity stocks are doomed and BP, of course, will have to cut its dividend — neither of which is a very likely outcome, in my opinion. 

It was always going to be a tough ride. 

Back in February we said that we anticipated a reset phase lasting around two years, during which our aim is to rebalance the Group’s sources and uses of cash to underpin our dividend,” BP’s boss, Bob Dudley, told analysts after BP’s latest trading update on 28 July. Since then, the stock has fallen — a lot, as it happened, recording a -14% performance in less than a month.

I am confident that positioning BP for a period of weaker prices is the right course to take, and will serve the company well for the future,” Mr Dudley added. 

I have no doubts that BP will deliver — and that view is backed by strong fundamentals, and its recent settlement of the 2010 oil spill.

Oil Prices Down… So What?

According to the oil and gas producer: “In the second quarter the Brent crude price averaged $62 a barrel, compared with $54 a barrel in the first quarter and $110 a barrel in 2Q 2014. In the third quarter to date, the price has averaged $58 a barrel,” BT said in its second-quarter results. 

If Brent crude continues to trade at about $45 a barrel, its price in the third quarter will average around $50 a barrel, which is only 9% below “$54 a barrel in the first quarter”, but back then BP traded between 392p and 457p. BP stock now trades at 335p — a stock price that is insanely low based on BP’s financials. 

In this environment, BP will likely be able to generate at least $20bn of unadjusted operating cash flow to support $18bn/$20bn of annual capital expenditures. That also depends on a number of variables, including working capital management, which should provide a boost in the second half of the year as its inventory converts into cash. 

Even if BP was to pay all the dividend to equity using cash on hand (40 cents a share for the year, or 10 cents quarterly), its implied net leverage would be well within reasonable levels. 

In fact, BP could raise more debt!

BP has accumulated a huge a amount of cash — more than $30bn — that it can use in torrid times such as these. Finally, it still has to fetch about $3bn from divestments, but even if we assigned zero to the value of those assets, I’d still be bullish!

Of course, if the Chinese economy hits a brick wall, growing only at 5% a year, we’ll have to reconsider the investment case. Regardless of whether you trust China’s GDP growth number or not, China is more likely to grow between 6.5% and 7% over the medium term — “which is not necessarily a hard landing scenario,” as a banker reminded me today. 

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.

Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Jumbo jet preparing to take off on a runway at sunset
Investing Articles

Down 70%+ since 2020, is IAG’s share price an unmissable bargain?

IAG’s share price is still down around 73% from its pre-Covid level, but with the business performing well last year,…

Read more »

A pastel colored growing graph with rising rocket.
Investing Articles

£17,000 of shares in the FTSE 100 dividend giant can make me £18,874 every year in passive income!

This FTSE 100 dividend superstar has an 8.8% yield with dividends projected to rise. It looks very undervalued to me…

Read more »

Investing Articles

2 top UK growth stocks I’m buying for my Stocks and Shares ISA in July

Looking for UK-listed growth firms to add to a Stocks and Shares ISA? Our writer highlights two he's planning to…

Read more »

artificial intelligence investing algorithms
Investing Articles

This overvalued growth stock makes Nvidia look cheap!

ARM Holdings is a growth stock that’s benefitted from the AI rally. Muhammad Cheema takes a look at whether this…

Read more »

Investing Articles

1 penny stock I’d buy today while it’s 63p

This penny stock's down 70% since last March, yet could be set for a big comeback as the firm rebuilds…

Read more »

Businessman use electronic pen writing rising colorful graph from 2023 to 2024 year of business planning and stock investment growth concept.
Investing Articles

Buying 8,617 Legal & General shares would give me a stunning income of £1,840 a year

Legal & General shares offer one of the highest dividend yields on the entire FTSE 100. Harvey Jones wants to…

Read more »

Man writing 'now' having crossed out 'later', 'tomorrow' and 'next week'
Investing Articles

£25k to invest? Here’s how I’d try to turn that into a second income of £12,578 a year!

If Harvey Jones had a lump sum to invest today he'd go flat out buying top FTSE 100 second income…

Read more »

Union Jack flag in a castle shaped sandcastle on a beautiful beach in brilliant sunshine
Investing Articles

2 lesser-known dividend stocks to consider this summer

Summer is here and global markets could be heading for a period of subdued trading. But our writer thinks there…

Read more »