2 Metals Stocks To Buy Now For Great Gains In 2013

May.10.12 | About: BHP Billiton (BHP)

By Kathleen Martin

Resource companies in the business of supplying base metals to industrial production, energy and minerals depend on demand to drive production and profitability. Demand has been the major driver of diversified companies such as BHP Billiton (NYSE:BHP), Anglo American (OTCPK:AAUKY), Alcoa (NYSE:AA) and Rio Tinto (NYSE:RIO). The challenges presented by current global economic factors are moving the major drivers to the supply side.

Lately, international players in the resource sector, particularly the sectors that serve the industrial production markets are faced with having to constantly adjust production outputs to keep costs in line in a world economy that is seeing little or good news. Producers are re-thinking exploration and development plans and consider production costs at existing properties, as labor and power costs rise. Decreases in demand brought about by Europe's prolonged debt crisis, slower growth in China and India have seen commodity price contractions in oil, iron ore and steel. As well surplus in aluminum stockpiles will keep prices low for the duration of 2012.

BHP Billiton has a portfolio of geographically diverse assets of base metals, iron ore, minerals, energy and petroleum. It operates in over 100 locations globally. Its strategy is to own and operate major, long-life, cost effective, expandable, assets diversified by commodity, geography and market.

The common shares trade around $69 and have a 52-week range of $62.54 and $97.37. The price earnings ratio is 8.13, the earnings per share are $8.51 and the dividend yield is 3.10%. The company's book value per share is $23.84. It has total cash of $4.36 billion and total debt of $25.07 billion.

BHP is committed to developing a portfolio of high return growth projects. In the first quarter of 2012, the company announced a $2.2 billion investment in the Escondida project in Chile. Expenditures will involve the replacement of an existing concentrator which will provide access to higher grade ore. The company also expended $414 million on the Escondida Oxide Leach Area Project. Funding commitments of $779 million has been given to iron ore projects and harbor construction in Western Australia. The funding will go to feasibility studies to progress, purchase of dredging equipment. A further $708 million was committed for the Gulf of Mexico which will provide detailed engineering for the building of a floating drill platform. The company's onshore drilling and development expenditures totaled $2.2 billion for the nine months ended March 2012.

Rio Tinto is an international mining group that concentrates on the development of premier ore bodies into large long life operations. It looks to its asset mix to sustain competitive advantages through different business and economic cycles. Rio has diverse interests in geography and product. Its assets are concentrated in Australia and North America, with other operations in Europe, South America, Asia and Africa. The company's assets are divided into five product groups: Aluminum and copper, diamonds and minerals, and energy and iron ore. There are two additional groups - technology and innovation and exploration.

Rio Tinto shares trade around $51. They have a 52-week range of $40.50 to $74. The price earnings ratio is 16.92. The earnings per share are $3.01. The dividend yield is 3.50%. Total cash is $10.01 billion. The total debt is $21.54 billion. The book value per share is $28.06.

Rio's metals unit produces everything from precious metals to alloys. The diamond group includes mining, refining and marketing although this group was offered for sale at the beginning of 2012 and Rio is currently considering offers.

The energy group has one of the largest productions of thermal coal for electrical generation. Rio is a major producer of uranium products for energy generation. Rio is the second largest supplier to the iron ore market behind Brazil's VALE (NYSE:VALE). It is the world's largest industrial salt for the chemicals industry producer. Technology and innovation is responsible for providing value to shareholders. The technology and innovation group focuses on improving current technologies with an emphasis on project evaluation, development and execution.

The CEO of Rio Tinto, Tom Albanses, is quoted as saying that the costs of keeping up the global supply of metals to meet demand, rising production costs and calls for buybacks and special dividends take away the incentive for producers to build new mines. It is becoming increasingly hard to find supply and resources. Shareholder activism, nationalization programs, new taxes, regulations, permit approval processes all contribute to a pullback in development and production activities by major resource players.

Rio anticipates that the supply side will now become the difficult portion of the business to manage whereas demand and surplus were the major challenges in the past. Increased labor, materials and power costs are now causing operators to reconsider potential exploration and growth prospects. Increased demands from governments that want a larger share of the resource is another chief consideration. Investors are now worried about capital intensive projects and making demands for more shareholder compensation in the form of dividends and share buybacks. Rio has more than $33 billion earmarked for capital expenditures in 2012. Rio may be re-considering coal expansion in Western Australia, due to capital costs and investor pressure to return more cash.

The results of elections in France and Greece see the rejection of austerity platforms to drive the economic recovery in Europe. Oil dropped on worries that the continued economic slowdown will cut demand. Companies that serve the Asia Pacific steel and aluminum markets are facing credit downgrades as profits are suffering from a supply glut and weak demand from slow growth. Aggressive capital spending plans, rising labor, energy and materials costs are also being considered in the credit outlook. Steel companies exposed to construction will suffer the most from any slowdown in growth in China.

The aluminum sector remains challenging despite cuts in supply by producers. Rising fuel costs in Indonesia and Mongolia, rising electricity costs in China, tight labor supply and energy cost increases in Australia are all major threats to operators in these regions. Companies need the flexibility to defer capital expenditures and disciplined spending by management to maintain a favorable debt rating. BHP and Rio both advised investors that there may be a slowdown in capital spending in Australia in light of the labor and energy costs concerns. Rio and Billiton also made investors aware that concerns over spending discipline are being carefully considered by management. These considerations will come at the expense of capital expenditures, so less supply will be coming on line.

It is that point in the resource market cycle when the guiding sentiments are changing from fear that supply will contract to the fear that demand will contract. Investors are growing wary of the huge differentials between commodity and stock prices and are demanding more compensation. Companies are trying to meet the investor demands and still expend capital in a way to remain competitive and cost effective in the markets served.

BHP has management that is able and capable of making decisions that will align production capabilities with demand. In the current climate that is shifting the drivers to the supply side, BHP will have to consider reductions in capital expenditures for exploration, cutbacks in production and a carefully executed distribution plan for shareholders. BHP is trading near its year lows and will probably see further declines as capital markets absorb the recent factors effecting commodity pricing, consumer and industrial demand.

BHP is a giant in worldwide industry. In the resource market bigger is the safe haven when the supply side is the major driver in the market. There are certainly many more things that could drive the share price lower, not the least of which are the prospect of new taxation or nationalization programs in the regions the company operates. However, BHP's long history of weathering tough markets and having the flexibility to exploit strategic markets coupled with the faint hope of recovery in the U.S. and continued growth in China all make for a buying opportunity. Investors who want resource exposure and are optimistic about industrial production recovery and growth should consider this stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.