Its been a challenging year for the mining sector, with declining commodity prices hurting investor sentiment and causing the valuations of Rio Tinto (LSE: RIO) (NYSE: RIO.US) and BHP Billiton (LSE: BLT) (NYSE: BBL.US) to come under severe pressure. In fact, their share prices have sunk by 11% and 21% respectively in the last twelve months and, with BHP Billiton reporting this week, its share price could be volatile in the short run.
Of course, for longer term investors, depressed prices of high quality companies such as Rio Tinto and BHP Billiton present a very enticing buying opportunity. If you could only buy one of the two companies, though, which should it be?
Clearly, BHP Billiton has been hit harder than Rio Tinto in the last year, with its share price falling by almost double that of its iron ore-focused peer. Despite this, Rio Tinto seems to offer significantly better value for money than BHP Billiton with, for example, it trading on a price to earnings (P/E) ratio of just 13, versus 15.8 for BHP Billiton.
Of course, BHP Billiton remains fairly valued while the FTSE 100 has a P/E ratio of around 16, but Rio Tinto has considerably more scope for an upward rerating over the medium term and, looking ahead, this could prove to be crucial for investors in the company. Thats because even if the two companies earnings numbers do not improve significantly, a perceived brighter future for the sector by the market could see Rio Tintos share price move upwards at a much faster pace than BHP Billitons.
One of the major negatives about Rio Tinto is the fact that it lacks diversification, with practically all of its profits being attributed to the sale of iron ore. BHP Billiton, on the other hand, has a much more diversified revenue stream and, in theory, this should provide it with a more stable earnings profile.
While that may be the case, Rio Tinto has significantly better growth prospects than BHP Billiton for the next couple of years. For example, its bottom line is forecast to fall by 25% in the current year, before rising by 18% next year. Given the challenging trading conditions currently present, this would be an excellent result, and show that Rio Tintos cost cutting and mothballing of major projects is having a positive impact.
Meanwhile, BHP Billiton is expected to post profit that is 40% lower this year, with growth of just 1% due for next year. And, even if the spin-off of South32 does go some way to improving the companys medium to long term growth potential, Rio Tinto seems to be one step ahead of its rival when it comes to bottom line increases.
While the short term will undoubtedly be volatile for both companies, there is great value on offer for long term investors through buying Rio Tinto and BHP Billiton. Both are financially sound and, due to maintaining high levels of production, are likely to emerge stronger (relative to their peers) from the current low ebb in the mining sector.
However, when it comes to which of the two to buy (if you can only choose one) then Rio Tinto offers significantly better value and, with its better growth potential, could see investor sentiment turn more quickly and more positively than for BHP Billiton. As such, Rio Tinto is the better buy of these two major miners.
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