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.
Billitons shares made an all-time high of over 26 in 2011, but, as Im writing, have just sunk to a new multi-year low of under 9. Rios 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, youll 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, youd be pursuing the one strategy that guarantees losses from the stock market: buying high and selling low. Youd have bought Rio and Billiton when higher prices were being touted as the new normal, and youd 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 youll 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, were 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 youre 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 were 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 Tintos forward yield is 6.7% and BHP Billitons 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 weeks news of a disaster at the companys jointly-owned Samarco iron ore mine in Brazil. Its 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.
I should say, though, that no mining company has made the cut for an elite group of five blue chips identified by the Motley Fool’s top analysts as the FTSE 100’s most compelling investments today.
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G A Chester 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.