Given the market's general enthusiasm for almost all equities these days, it takes a rare sector to present significant opportunity to value investors and fewer still present opportunities for decent income from dividend yields. However, there is one sector out there that seems to offer both right now, but only if investors are willing to be patient and run the risk of short-term price volatility in the service of long-term outperformance. I am talking here about the global mining sector.
Enormous multi-national firms like Vale (VALE), Rio Tinto (RIO), BHP Billiton (BHP) , (BBL), and even Freeport-McMoran (FCX) all offer significant yields at prices that are at or close to multi-year lows. If this were the middle of an economic expansion it would be easy to understand why BBL for example is trading at the same place is was in mid-2010, but given the economic environment in the past few years, can anyone truly say that the world is economically riskier than it was in January of 2011 or January of 2012?
With Europe looking far less likely to implode overnight, and perhaps the slimmest of possibilities the economic situation there is healing, one would think that global miners would be helping to lead the market higher. Instead, largely on fears that China is slowing down, miners are in the doldrums. And investors should be cheering! Because while so many other stocks are fully valued, it's fairly clear that the miners could have a lot of room to run if the current economic gloom is at all overstated.
What's more, all of the miners are paying significant dividends that compensate investors who are willing to wait for the gloom to abate. For example, according to S&P, Vale sports a 5.28% dividend, a book value of $12.65, and the firm is estimated to earn $2.56 in EPS this year, all with a current stock price of about $15.50.
Mining bears will be quick to tell you that the earnings on these companies are sure to come down in the next year given the surplus of steel and copper and the falling prices for all commodities. And frankly they are probably right. An awful lot of relatively poor investments in mines were made in the last few years on the assumption that China would keep growing at 10%. That was a bad assumption on their part, and the value of some of these mining assets will have to be written down - but the big miners appear to have the financial wherewithal to handle this and they are already making plans accordingly.
RIO and BHP have both come out in the last few months with plans to significantly curtail their capital expenditures next year. VALE said at the end of last year that it plans to cut its capital expenditures by 24% for 2013. All of this suggests that the miners are aware of the challenges they face and are focused on improving shareholder returns. In fact, one could even argue that the depth of these cutbacks bodes poorly for Caterpillar (CAT), Joy Global (JOY), and Terex (TEX), but given the ongoing need for urbanization in China, and a slowly rebounding U.S. economy, it's likely that the equipment makers will be alright in the medium term as well.
The chart below compares the miners against one another and illustrates why they are worth taking a look at for investors looking for long-term value plays.
As the chart demonstrates, all of these firms have substantial book value, and strong cash flows. In general, the PE ratios on the firms are quite low compared with the market and their own historical performance.
That said, there are two points particularly worth noting in this table, which also illustrate the risks of the sector. First, RIO had negative earnings per share last year, despite having significant cash flow per share. This was driven by asset write-downs by the company, which significantly impaired earnings. When looking at the asset heavy mining firms, write-downs can quickly reduce book value and create negative headlines for a stock.
Similarly, FCX illustrates the second significant risk for mining firms. While FCX's LT Debt/Asset ratio is quite low, the firm also faces a large amount of current debt coming due (about 3.5B on 35B in assets with another ~3.5B in long-term debt). If capital markets freeze up, FCX could face trouble rolling this debt over and that would create significant liquidity challenges for the firm. FCX is unusual in that it faces so much debt coming due in a single year, and this is driven at least in part by the firm's unconventional merger with McMoran Exploration (MMR) and Plains Exploration (PXP).
Yet mining stocks have significant potential to grow if global growth resumes (which at least the last 30 years of history suggests it will… eventually), and in the meantime, these mining stocks offer attractive dividends to those investors willing to wait as the chart below shows.
52 Wk High/Low
With stocks like Vale and Rio Tinto trading at levels not far above the financial crisis trough, these stocks are certainly worth looking at for any investors who are willing to wait for global growth to begin a rebound.