Unearthing 2 Undervalued Mining Gems

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 |  Includes: BHP, RIO
by: Yiannis Mostrous

Despite its recent woes, I am still bullish on Rio Tinto (NYSE: RIO), a well-managed company with solid prospects for growth. The stock is undervalued right now, making it more attractive than ever.

Global demand for this miner's key products, including iron ore and copper, are expected to double over the next decade, driven by demand from China, India and other emerging economies.

However, the stock has been trading at a discount as this British-Australian miner battles a prolonged slump in the aluminum market, which is diluting returns and margins. Without the aluminum division, the company should be considered as one of the best mining assets to own.

Rio's production of iron ore and copper accounts for more than 85 percent of earnings, with margins higher than that of fellow Portfolio denizen BHP Billiton (NYSE: BHP). However, losses from aluminum are dampening overall performance.

Unfortunately, the company has not been able to sell any of its aluminum assets. The good news is that aluminum constitutes a small portion of Rio's business, which means problems in this segment won't significantly hurt the company's valuation.

Moreover, despite continued uncertainty in Europe and a weak US economic recovery, Rio's order books are full. Rio's superior asset base and the high quality of its growth pipeline will likely push the stock higher this year.

Rio also is USD250 million into its USD1 billion of planned cost savings, with the balance slated for completion by mid-2014.

Investors who buy Rio Tinto now are getting a company with enormous growth prospects at discounted prices.

BHP Billiton reported that earnings in fiscal year 2012 dropped 21 percent to $17.1 billion, which still beat consensus estimates of USD14.6 billion. Underlying EBITDA declined 9 percent to USD33.8 billion.

BHP attributed the decline in earnings to weak commodity prices and industry-wide pressures to cut production costs. That said, it's our view that infrastructure investments in China and other emerging markets during the latter part of this year is likely to serve as a catalyst for a structural bull run for commodities.

In response to flagging demand, management has taken proactive measures. The company shut down high-cost production, by ceasing expansion of its major copper operations at the Olympic Dam open-pit mine in Australia. The company also shuttered mining of silicon managenese in South Africa and coal in Australia.

BHP's revenue was flat in fiscal 2012, increasing only 0.7 percent to USD72.2 billion, as euro zone worries and China's slowdown dampened manufacturing and construction around the globe, reducing demand for iron ore, metallurgical coal, stainless steel, aluminum, and base metals.

However, the US is becoming a major source of revenue for BHP. The company expects to spend around USD4 billion on its onshore US operations, an increase of USD300 million from last year. The company operates four drilling rigs in the Haynesville and Fayetteville dry gas basins in Louisiana, while 80 percent of its rigs are targeting the liquids-rich Eagle Ford Shale in south Texas and the Permian Basin.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.