There is a mining boom based largely on wildly-oversized construction spending in the People's Republic of China. This can't continue forever, and mining-sector stocks often risk price drops for their commodity products. Moreover, governments are keen on taxing mines and restructuring rights to natural resources. Given these risks, investors should only invest in miners at attractive valuation multiples.
Congo Government Wants 35% of Mine Projects in Code Changes
Governments love to lean on mining projects. After all, it's not like miners can relocate their projects hundreds or thousands of miles away.
A report from the Democratic Republic of Congo business association revealed that the government is planning to increase its involvement in mining projects from five percent to thirty five percent. It also plans to increase the amount of royalties charged on mineral exports. Martin Kabwelulu, the Mines Minister said, "These proposals will be submitted to all parties for a consensus."
Cliffs Cuts Iron Production
Beyond government confiscation, there is simple market risk that confronts commodity producers.
Cleveland-based mining company Cliffs Natural Resources (CLF) announced it will lay off approximately 625 staff after it shuts down and scales down projects in Minnesota, Michigan and Quebec due to poor iron demand. Its Empire Mine in Palmer, Michigan will dissolve 500 jobs. It had also postponed plans of expansion in its Bloom Lake mine in Quebec.
Cliffs spokeswoman Sandy Karnowski said:
It's a tough day for all of us at Cliffs and we're hopeful to see the market conditions improve in the future.
The Center for Applied Research and Technology Development made a statement that several supply-demand factors explain the slump in iron prices. Global economic crisis, rising demand for steel versus iron, and automatic federal tax increases will limit prices of iron ore.
It is hoped that Minnesota's iron mining industry will recover based on the new Magnetation, Essar Steel, and Mesabi Nugget projects on the Range, and U.S. Steel's (X) plans to expand its Keetac operation. There is also short-term optimism for the region because relief efforts in the aftermath of Sandy will boost the construction industry, and demand for brand new home appliances will stimulate demand for iron. China's higher public infrastructure spending will also attract demand for iron in the global market. Unfortunately, the macro picture for iron is bleak, regardless of project investments or short-term demand spikes.
Vale Controls Costs
Vale (VALE), the world's biggest iron-ore company, seems to have a good grip on the weak demand for building materials. Vale's CEO Murilo Ferreira said that the company is delaying some of the company's biggest projects. Vale stated:
We will conclude projects already under execution, while research and development expenditures are being cut to give rise in the future to a smaller and more select portfolio of projects....2012 is very likely to be the peak year for capital expenditures in the foreseeable future.
This is an appropriate change in strategy in response to dropping commodity prices. Europe and China are the largest markets for the company's mineral and metal products, but are not growing like they used to.
According to Vale's CFO Luciano Siani, the company is looking to sell stakes in the potash project in Argentina and the Moatize coal project in Mozambique. He said:
The decision has been made but we are still exploring the market to see what's the possibility to realize value on the sale as well, we are not going to fire sale any asset.
Given the macro picture, investors should demand low valuations for miners.
BHP Billiton (BHP) is not attractive at $71 per share. Investors can buy more revenues per dollar from the S&P 500, since this index has a price-to-sales ratio of 1.30, while this stock has a much higher 2.61 ratio. The price-to-book multiple of this stock is 2.87, higher than the 2.02 S&P 500 average. BHP Billiton shares are trading at a 12.28 price-to-earnings ratio, lower than the 14.01 average of the S&P 500 index. This is not much of a discount.
Rio Tinto (RIO) stock is more richly valued at a roughly $48 per share. Rio Tinto shares are trading at a pricey 22.01 price-to-earnings ratio, a number which is almost double the S&P 500 average. The firm's 1.57 price-to-sales ratio is in line with today's prevailing market multiples. The price-to-book multiple of this stock is 1.60, somewhat cheaper than the 2.02 S&P 500 average. Taken as a whole, these valuation multiples are not significantly lower than the broader market and do not justify the risks taken by investing in the mining industry.
Fortunately, shares of Cliffs Natural Resources are more reasonable. At prices near $31 per share, the firm's 0.72 price-to-sales ratio, 4.90 price-to-earnings ratio, and 0.70 price-to-book multiple are attractive. The firm's reasonable 0.54 debt-to-equity ratio demonstrates that the firm is not overleveraged.
Cliffs Natural Resources shares offer a dividend yield of 8.0% dividend which is much higher than treasury yields. Future dividend payments are likely because the company pays out 0.15 of earnings as dividends, so earnings could drop considerably before dividends must be cut.
Vale is clearly a better investment prospect at $17 per share. The firm's 1.93 price-to-sales ratio is a touch higher than today's prevailing market multiples. Vale shares are trading at a low 7.68 price-to-earnings ratio and a low 1.12 price-to-book multiple, less than the S&P 500 index. The firm's reasonable 0.38 debt-to-equity ratio demonstrates that the firm is not overleveraged.
Vale shareholders enjoy a 3.50% dividend yield. Its dividend payout is likely sustainable because the firm's 0.34 payout ratio is below the 0.6 rule of thumb for maximum sustainable dividend payouts.
These companies are risky, but at least Cliffs Natural Resources and Vale are cheap. Investors should consider them as speculative plays based on attractive valuations and management, which is not afraid to shut down projects during periods of declining demand.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.