Shareholders of FTSE 100 mining giants Rio Tinto (LSE: RIO) and BHP Billiton (LSE: BLT) are suffering a dismal time. If you bought shares in these two companies at any time in the past six years your holdings will be in the red — deeply in the red in many cases.
Billiton’s shares made an all-time high of over £26 in 2011, but, as I’m writing, have just sunk to a new multi-year low of under £9. Rio’s shares have fallen from £47 in 2011 to around £22.50 now.
Once again, mining has shown itself to be a highly cyclical industry. Yet at the extremes of boom and bust, you’ll always hear talk of “new normals”, “secular-this” and “structural-that”, suggesting (in boom times) that higher prices for natural resources are a permanent new feature and (in bust times) that lower prices are the benchmark for the future.
If you invested by listening to this sort of stuff, you’d be pursuing the one strategy that guarantees losses from the stock market: buying high and selling low. You’d have bought Rio and Billiton when higher prices were being touted as the new normal, and you’d be selling today on bearish views that lower prices are here to stay.
Of course, you should be aiming to do the opposite. Look at history, and you’ll see the same repeated cycle: periods when demand for natural resources outstrips supply, periods when supply and demand are broadly in balance, and periods when supply exceeds demand.
Right now, we’re in a phase of over-supply, metals prices are low, and the shares of mining companies have crashed. Demand for natural resources from China may have slumped as the country moves from heavy infrastructure investment to a more consumer-oriented economy, but, long-term, global urbanisation will continue, and there will be times when demand outstrips supply.
Given where we are in the cycle, dumping Rio and Billiton today is unlikely to be a wise move in the long term. Indeed, I would say buying shares in these two companies looks a far better idea right now.
In the short term, the shares may, or may not, go lower still. Nobody knows. No trumpets sound to tell you when shares have hit their bottom. If you’re a long-term investor — which is the way of the Motley Fool — all you should be doing is looking at what Rio and Billiton are offering today, the near-term risks and the potential long-term rewards from cyclical recovery (dismissing, I would suggest, any notion that low prices are a new normal).
Rio and Billiton have a lot going for them. Both have relatively new chief executives, who are focused on shareholder returns, rather than empire-building; both have world-class assets; and both are low-cost producers. They are well-placed to weather the current slump, while high-cost producers are forced out of the market.
Multiples of current depressed earnings mean little, if we’re long-term investors, holding for a cyclical recovery, and the next boom that will see Rio and Billiton surpass previous peak profits — which, at some unknown point in the future, will happen.
The current dividend yield, on the other hand, means quite a lot. Rio Tinto’s forward yield is 6.7% and BHP Billiton’s is a massive 9.1%. If the companies are able to maintain their dividends, reinvesting such a high proportion of your initial investment would see a huge snowballing of your stake in the businesses, and a massive compounding of your returns when the cyclical recovery comes.
The boards of both companies have expressed their commitment to their dividends. However, as the size of the yields suggests, the market sees some risk of a cut; and, as the difference in the yields suggests, the market sees a greater — and, indeed, significant — risk of a cut at Billiton. In fact, the risk at Billiton has just increased a notch, with last week’s news of a disaster at the company’s jointly-owned Samarco iron ore mine in Brazil. It’s been suggested that the cost to Billiton could be as much as $1bn.
Nevertheless, even if Billiton or Rio halved their dividends, the yields would remain decent, and I view it as highly unlikely that either company would halt dividends altogether. As such, both stocks appear good value to me at their current levels for patient, long-term investors.
