China has been on my mind for some time now. It responded to the financial crisis by embarking on a credit-fuelled infrastructure blitz, creating a $23 trillion credit bubble. Now the authorities are trying to find a way out.
Even if they do engineer a soft landing, China was never going to gobble up as many metalsasBHP Billiton (LSE: BLT) (NYSE: BBL.US) and Rio Tinto plc (LSE: RIO) (NYSE: RIO.US) could unearth. You cant carry on building apartment blocks, roads and railways forever.
At some time the slowdown had to come.
With this in mind, I sold my stake in BHP Billiton six months ago, and Im glad I did. At todays price of 1659p, it is now 21% off its 52-week high of 2102p.
Rio is 18% off its year-high of 3602p
Yet analysts have remained loyal toBHP Billiton and Rio Tinto. It baffles me that Citigroup and Deutsche Bank confidently maintain a buy rating on both, while Barclays Capital is overweight, when I reckon the miners are at the sharp end of a nasty secular trend.
Yet in a way, both companies deserve their positive reviews. Management appears to have adopted the right strategy for difficult times, cutting costs, boosting productivity, and slashing capital and exploration expenditure.
Despite my carping, BHP recently reported a 10% leap in adjusted full-year profits to $13.45bn, while Rios half-year earnings rose 21% to $5.1bn. Theyre clearly doing something right.
They have combined this with progressive dividend hikes, which, allied with sliding share prices, means that BHP now yields 4.5%, while Rio yields 3.95%.
Both companies have drawn praise for their impressive double-digit output gains but this seems like a double-edged sword to me. Boosting supply as demand falls can only force prices in one direction.
As a globally diversified companies, BHP and Rio have much greater protection than smaller miners, many of which are sinking into the red. Standard & Poors recently downgraded Cliffs Natural Resources Inc, the biggest US iron miner, to junk status, largely due to the falling iron ore price.
Optimistic may argue that this could ultimately work in favour of BHP and Rio, if less financially robust competitors are driven out of business.
If youre similarly optimistic, now could be a good time to buy BHP and Rio. At 10.6 and 8.8 times earnings respectively, thiscould be a good entry point.
Only do this if you are prepared to play the long game. And note that BHPs earnings per share are forecast to fall 10% in the year to next June.
Rios EPS will fall 9% this calendar year, but may rebound4% in 2015.
Dont Blame It On Rio
These are both well-managed companies, but their biggest customer is in trouble. Chinese industrial expansion is at its weakest since the financial crisis, according to a recent World Bank report, as the government battles to address financial vulnerabilities and structural constraints.
As the Federal Reserve tightens, and the dollar strengthens, hot money is draining out of emerging markets and commodities.
BHP Billiton and Rio Tinto are better placed than most miners to survive the commodity crunch, but they wont escape it altogether.
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Harvey Jones 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.