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Is It Time To Sell Vedanta Resources plc And Buy BHP Billiton plc?

Global diversified mining giant, Vedanta Resources (LSE: VED) is falling today after the company issued a mixed production update.mincon.1

The India-focused miner reported that during the first half of the year, the company’s gross oil production declined by 3%, while refined zine output was also lower than the corresponding period due to unplanned maintenance activities and lower grades of ore mined. On the other hand, Vedanta reported a higher level of copper and power output for the period. 

Unfortunately, this mixed update has not been enough to convince investors that Vedanta is worth its lofty valuation. Even after today’s declines, the company is trading at a forward P/E of 21.8, a valuation more suited to a high-growth tech company rather than a miner. What’s more, both BHP Billiton (LSE: BLT) and Rio Tinto (LSE: RIO) are more attractive based on current valuations. 

Time to buy

As iron ore miners, Rio and BHP have both seen their share prices fall in line with the price of iron ore over the past month or so. However, these declines have presented the perfect opportunity to buy, as the two mining behemoths have spent a long time planning for this iron ore market weakness. 

Actually, it’s widely assumed that both BHP and Rio have created this market weakness as they ramp up their production of iron ore. The iron ore market is already over supplied and additional supply is only depressing prices further. Nevertheless, with BHP’s and Rio’s average cash cost of production per ton of iron ore in the low $30’s, the two miners will be able to weather price declines.

Additionally, like Vedanta, BHP produces other assets aside from iron ore. BHP has built itself around a ‘four pillars’ strategy, producing four key commodities — iron ore, copper, petroleum and coking coal — which means that the company is not overly exposed to the falling iron ore price.

Low valuation 

Unlike Vedanta, both BHP and Rio now trade at low, attractive valuations after recent declines. For example, BHP currently trades at a forward P/E of 11.8 and Rio trades at a forward P/E of 9.6.

That being said, as Rio is predominantly an iron ore producer, the company is likely to see its earnings fall significantly this year. Indeed, City analysts have estimated that a $1 drop in the average iron ore price, wipes out $135m of annual net profit after tax at BHP Billiton and $122m at Rio. 

Still, despite falling profits, the two mining giants support attractive dividend yields that are well covered by earnings per share. Specifically, Rio currently supports a dividend yield of 4.4% and the payout is covered three times by earnings per share. BHP supports a dividend yield of 4.6% and the payout is covered twice by earnings per share.

In comparison, Vedanta does support a dividend yield of 4.1% at present levels but last year the payout wasn’t covered by earnings. The City’s current figures suggest that Vedanta’s dividend payout will be covered just once by earnings per share this year, which does not leave much room for growth.

Long term

BHP and Rio are great long-term investments due to their size and low cost of production. Long-term, buy and forget investing is a key part of wealth creation, something every serious investor should be well aware of.

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Rupert Hargreaves 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.