FTSE 100 income shares under pressure
Shares in Rio and BHP have declined by 40% and 44% respectively over the past few weeks. Investors have been selling the shares because it looks as if these businesses will suffer a dramatic decline in demand for their output over the next few months.
Indeed, initial estimates from Goldman Sachs suggest global demand for all commodities has declined around 25% since the beginning of 2020.
However, BHP and Rio’s size means that these FTSE 100 income shares are, to some extent, insulated from the market turbulence.
For example, Rio’s average production cost per tonne of iron ore is below $30. That’s compared to the current market price of $90. These numbers suggest Rio is still making a healthy profit on its iron ore production. It should continue to earn a profit on production even if prices fall a further 50% from current levels.
The same is true of BHP, the world’s biggest miner by market capitalisation. It reported that unit costs at its Pilbara iron ore operations in Western Australia fell below $13 per tonne last year.
That’s the lowest cost of production for the commodity in the world. The company is also earning a margin of more than 100% on its copper production. That’s even after recent price declines.
These competitive advantages suggest that BHP and Rio will be able to emerge from the current situation in relatively good health. Further, both companies have robust balance sheets. At the end of its last reporting period, BHP’s net gearing ratio was 25.8%. After several years of focusing on reducing debt, Rio’s rate was just 8.5%.
There have also been suggestions that China will undertake a massive fiscal stimulus to kick-start the country’s economic recovery. If it happens, this should support commodity prices. That can only be good news for Rio and BHP.
For its part, BHP informed its investors last week that, so far, “operations had not been materially impacted so far by the coronavirus pandemic.“
Considering all of the above, it seems as if the market has overreacted by sending the shares of these FTSE 100 income shares down 40%. They have low production costs and strong balance sheets. And the potential for economic stimulus suggests they are well-placed to navigate the current economic environment. They could even emerge stronger if smaller competitors with higher costs are forced out of business.
As such, now could be the time to make the most of the market’s short-term outlook. After recent declines, shares in Rio are trading at a price-to-earnings (P/E) ratio of just 8. BHP is dealing at a multiple of 7. Considering how well community prices are holding up, it appears as if these estimates remain accurate.
Shares in Rio also currently offer a yield of 8%. Meanwhile, BHP offers its investors a yield of 10%. Even if the two companies cut these distributions in half, yields of 4% and 5% are still highly attractive in the current interest rate environment.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.