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Summary

  • Chinese iron ore imports will remain strong this year.
  • Drop in iron ore price could affect Vale more than Rio and BHP.
  • BHP seems better for investment when compared to Vale and Rio.

Vale (NYSE:VALE), Rio Tinto (NYSE:RIO) and BHP Billiton (NYSE:BHP) being the leading mining companies, cater to most of the world's demand for mineral ores. All the three mining companies generate most of their revenue from iron ore and coal sales. China is the world's top buyer of iron ore and coal, and also the major customer of these companies, so every positive improvement in the country's economy is favorable for the companies. In 2013, Vale and Rio generated 40.5% and 35.4% of their revenue from sales to customers in China, respectively.

Demand for Chinese iron ore, coal and nickel products depends on the demand for steel. China's crude-steel output is expected to rise 3% to 815 million tons this year. Consumption of steel in China will increase from nearly 700 million metric tons in 2013 to more than 900 million metric tons by 2018. According to forecast, the country's iron ore imports will rise 12% this year to 921 million metric tons compared to last year. China's dependence on imported iron ore will increase from 72% of its consumption in 2013 to 77% in 2016. In 2013, Chinese demand represented 64.3% of global demand for seaborne iron ore. Vale, BHP and Rio supply a combined 70% of China's iron ore.

China will remain dependent on imported iron ore because of its high cost of production. Chinese ore costs around 457 yuan (($75)) a ton to produce, compared with $30-$60 a ton for imported ore. Rise in Chinese iron ore demand could also help stop the price slide. As the world's largest consumer of iron ore, China has a significant impact on iron ore prices. According to data from the The Steel Index, the import price of 62% iron ore fines at China's Tianjin port added $1.20 to $119.40 per tonne as imports from top consumers China is expected to resume its record breaking pace. Although, the iron ore prices are expected to decrease little in the future, but still these miners will make significant profits, as they are producing iron ore for less than $50 per tonne. Analysts are forecasting iron ore to average $100-$119 in 2014.

Looking at coal, coal demand is rapidly increasing in Asian countries like China and India. Over the last few years, coal imports from China and India have been increasing at a compound annual rate of over 20% each year. Currently, China is the largest purchaser of coal in the world. Coal demand is growing quickly in India, and is expected to become a bigger importer of coal than China within the next five years. Global coal demand is forecast to grow by 1.2 billion tons in the next five years, and more than 80% of this growth in demand is expected to come from India and China.

Chinese coal demand is likely to reach 4.89 billion tons in 2017 from 4.07 billion tons in 2012. India's demand for coal will increase from 726 million tons in 2012 to 920 million tons by 2017, a growth of 26.7%. Between 2012 and 2017, China's coal imports are estimated to increase from 289 million tons to 400 million tons. During the same period, India's imports of coal will surge from 137 million tons to 265 million tons, a growth of 93.4% in five years' time. In India, steelmakers meet 60-65% of their metallurgical coal requirements through imports. This is because domestic coal reserves have high ash content and are therefore not suitable for use in the steel industry.

Of the three miners, BHP has the most diversified production, as a result, it is less dependent on any one particular commodity such as iron ore or coal. BHP generates only half of its profit from iron ore. In contrast, Rio and Vale get 80% and 82% of their profit from iron ore, respectively. This allows BHP to mitigate the risks that a declining iron ore price poses for its sales and profitability. According to Barclays estimate, 10% drop in iron ore price reduces BHP's earnings by 9.4%. A similar drop in iron ore price reduces Rio and Vale's earnings by 15% and 28.4%, respectively. Both BHP and Rio are closer to China and India, thus their shipping costs are low when compared to Vale.

Performance and Valuation Analysis

VALE

BHP

RIO

Industry

Market Cap.

$76.06 B

$187.30 B

$102.99 B

N/A

5yr Revenue CAGR

8.15%

2.09%

-1.17%

2.61%

P/E (ttm)

1341.36x

12.64x

28.53x

13.22x

Forward P/E 2 year

8.20x

12.55x

9.67x

N/A

Price/Sales

1.55x

2.77x

2.06x

0.90

Price/Book

1.06x

2.45x

2.27x

0.49

EPS

0.01

5.58

1.97

N/A

Return on Assets (ttm)

8.51%

8.95%

5.12%

0.60%

Return on Equity (ttm)

-0.17%

21.45%

1.94%

1.72%

Dividend yield

0.70%

3.40%

4%

1.38%

Dividend payout

668%

56%

89%

10.41%

Current ratio

2.54

1.22

1.45

N/A

Total Debt/Equity ratio

50.26

46.22

53.22

N/A

Looking at revenue growth, Vale's five-year revenue CAGR is 8.15% while Rio and BHP five-year revenue CAGR is -1.17% and 2.09%, respectively. The reason behind Vale's rapid growth is the rise in iron ore price and demand, as its exposure to iron ore is higher than Rio and BHP.

BHP's return on assets ratio is higher than Rio and Vale. Higher return on assets means the company is more efficiently using its assets which is a sign of great management. Another important metric is return on equity. BHP's return on equity is also much higher than Vale and Rio, which means BHP makes more profit than Vale and Rio with the money that you invest.

Currently, BHP has a two-year forward price multiple of 12.55x, the highest amongst the three. This determines that investors expect stronger growth in BHP. Looking at Price/Book and Price/Sales ratio, Vale seems undervalued as compared to BHP and Rio.

Bottom Line

Due to increasing steel consumption, Chinese iron ore and coal demand will remain strong in the coming years. This will benefit all the above mentioned companies. Besides China, India is also becoming an important market for miners. Due to rising iron ore and coal demand, these companies will deliver solid returns to their investors. However, If I have to choose one among the three, I will prefer BHP over Rio and Vale.

Source: Which Diversified Miner Should You Buy?