The mining sector has been akin to a slow-motion car crash for much of the last couple of years, with investor sentiment becoming so weak as to push valuations to multi-year lows. Clearly, this is not without good reason: the prices of a range of commodities have come under huge pressure and left mining companies seeking out cost savings and production increases so as to try and offset the hugely challenging trading conditions being experienced.
One company which is coping better than most with the tough climate is Rio Tinto (LSE: RIO). Its business has been centred on the production of iron ore and, since the steel-making ingredient has fallen in price to a ten-year low, its profitability has come under severe pressure. For example, in the current year its bottom line is forecast to fall by 48% and then by a further 5% next year. Although these figures are very disappointing, for many mining companies things have been far worse.
Moreover, Rio Tinto remains financially very sound. It has a strong balance sheet and its cash flow is adequate to cover both dividend payments and sustaining capital expenditure, which means that its viability as a business is not in doubt. As a result, it has the potential to come through the present challenges and emerge as a stronger business relative to its peers so that when commodity prices do stabilise, it is able to generate a higher level of profitability from having an increased market share.
While Rio Tinto may not be the most stable of businesses, its yield of 6% remains hugely appealing. And, for investors who are less risk averse and take a long term view, its price to book value (P/B) ratio of 1.3 is very enticing and indicates that capital growth is on the agenda in 2016 and beyond.
Similarly, Anglo American (LSE: AAL) also appears to be a strong buy at the present time. Unlike Rio Tinto, though, the diversified mining company has been loss-making in recent years and, as its half year results showed, it is being forced to make severe cuts to capital expenditure as well as cost savings.
For example, Anglo American is making additional capital expenditure reductions of $1bn by the end of 2016 and is also seeking to deliver $1.5bn in productivity gains and other efficiencies in the second half of 2015 and into 2016. Furthermore, it is selling-off non-core assets such as its loss-making South African platinum mines and it is also restructuring the business to provide better exposure to the commodity price cycle, while maintaining the appeal of its highly diversified operations.
While its results have been disappointing, Anglo American’s P/B ratio of 0.48 indicates that it has a sufficiently wide margin of safety to merit investment at the present time. Clearly, it is a relatively high risk investment due to the high degree of uncertainty regarding commodity prices. But, for investors seeking to buy low and sell high, now appears to be the right time to buy a slice of Anglo American.
