As we come to the end of a tough year for mining investors, is it time to take a fresh look at the big cap miners?
Valuations are at 10-year lows in many cases, even for firms such as Rio Tinto (LSE: RIO), Antofagasta (LSE: ANTO) and Randgold Resources (LSE: RRS) — all of which remain highly profitable.
I think there’s a growing case to suggest that mining shares are now close to the bottom. Current valuations seem to imply that there will be little or no improvement in earnings over the next few years, and that commodity prices will remain at record lows.
This seems unlikely to me.
Markets rarely remain static for long. Although there is a surplus of supply for many commodities at the moment, the current lack of investment in new projects means that this surplus will gradually dwindle.
I don’t expect mining shares to rocket higher in 2016, but I do think that there will be signs of stabilisation and some modest gains. The exception to this will be if the Chinese economy really collapses, rather than simply experiencing slower growth. In that scenario, things could get a lot worse for miners.
If you are thinking about taking a position in mining stocks, do any of the three companies I’ve mentioned look attractive buys?
Rio Tinto
As a long-term Rio shareholder I remain a big fan of the stock’s income potential. I have increased my holding this year. Rio is currently valued at around 12 times 2015 forecast earnings, with a 6.7% prospective dividend yield.
Rio stock now trades at just 1.4 times its book value. The firm generated $2bn of free cash flow during the first half of the year, while I expect this to have fallen during the second half, I don’t think the dividend will be cut.
Rio took advantage of the strong market of the last few years to reduce net debt and cut capital expenditure. As a result, the firm’s dividend was covered 1.5 times by free cash flow last year. At 2,200p, Rio is an excellent long-term buy, in my opinion.
Antofagasta
Shares in copper miner Antofagasta have fallen by almost 70% from their peak of five years ago. It’s been a painful decline, but like Rio, Antofagasta shares now trade close to their book value.
I think this is a short-sighted view. Antofagasta’s net cash cost of production was $1.53/lb during the first half of the year, significantly below current copper prices of $2/lb. The firm has also added further low cost production with the recent acquisition of a 50% stake in Barrick Gold’s Zaldivar copper mine.
When the price of copper starts to recover, I believe Antofagasta’s shares could rebound quite sharply.
Randgold Resources
Randgold has never been a cheap stock, but the quality of the firm’s assets means that they remain profitable and cash generative as long as gold remains above $1,000 per ounce. That’s why Randgold has continued to increase both its dividend and its net cash balance throughout the gold bear market.
This is a very high-quality business. Although Randgold shares do seem expensive, with a 2016 forecast P/E of 25, the group’s operating margins could rise very quickly if the price of gold starts to recover next year.
