The shares BHP Billiton (LSE: BLT) (NYSE: BBL.US), Rio Tinto (LSE: RIO) and Anglo American (LSE: AAL) roared back from their one-year lows on 13 October in the wake of relatively upbeat economic data from China. Two weeks later, they still trade around their lows for the year. Do their depressed valuations offer a bargain right now?
Under Pressure
Rio stock is down 11% this year. It has lost 17% of value from the high it recorded in the first quarter. By comparison, BHP stock has lost 12% of value in 2014 and trades around 22% below its one-year high. It can be argued that most of slump came on the back of high expectations for shareholder-friendly activity such as stock buybacks — particularly for BHP — that didn’t materialise earlier this summer. Other elements weighing on the valuations of these two miners are the outlook for China and corporate strategy.
China
At the end of September, Goldman Sachs joined brokers in the bear camp and cut its gross domestic product growth forecasts for China to 7.3% — around half a percentage point below the growth rate for 2013. China’s GDP in the third quarter grew by 7.3%. That’s the lowest level on record since the first quarter of 2009, when the stock market rally started.
Both Rio and BHP generate more than one third of revenue from China, which means that if the Chinese economy grows above consensus estimates, their shares will fast appreciate in value. If China continues to slow down, as it seems likely, the shares of Rio and BHP will struggle to deliver value.
Iron Ore Strategy Under Scrutiny
Iron ore represents 50% and 31% of revenue for Rio and BHP, respectively. Both miners are increasing production of their existing assets in a low-demand environment, with iron ore prices plunging by 40% this year.
Price, the argument goes, still has to fall but it will reach equilibrium at some point and by then Rio, BHP and the likes will have gained market shares as a lower cost base will allow them to sell iron ore in volumes. Well, I haven’t crunched the numbers, but this is a very risky strategy that could easily backfire.
In this context, persistent pressure on oil prices – which trade about 25% below their level from June – may offset downward pressure on profitability and cash flows.
Anglo American: The Outlier?
Anglo stock is up 1.2% for the year. It has lost 21% of value from its annual peak. The stock rallied earlier this year as investors were willing to bet on a comprehensive restructuring plan comprising divestments. Management have ambitious targets for returns, but better returns could be achieved in other sectors.
