One year ago, investors had expected cash returns in the region of $ 5bn from BHP Billiton — the miner gave them a break-up instead that did little to lift confidence. However, the bulls still talked of value in the mining sector, with several analysts arguing in favour of a few other stocks such as those of Anglo American (LSE: AAL), Rio Tinto (LSE: RIO) and Glencore (LSE: GLEN).
They Are Cheap (We Were Told In 2014)
What a difference a year has made: Anglo stock is down 50% over the last 12 months, while the shares of Glencore and Rio Tinto have fallen by 43% and 30%, respectively.
I warned you last summer: “if you think that the shares of miners have peaked, you may well be right,” I wrote on 19 August 2014.
What’s next now?
China & Valuation
The Chinese economy is not going to bail out the mining world, but at a time when commodity prices continue to drop, the bulls may be entitled to think that some value resides in a few cyclical stocks that have been hammered in recent months — after all, the CRB Commodity Index — a commodity futures price index — trades at multi-year lows and will not fall forever.
Is that right? If so, the mining sector could offer plenty of upside.
Rio has been a target for Glencore for some time, so both could be a decent bet on consolidation. Anglo is a target, too, and if the industry consolidates then a change of ownership will likely be on the cards.
Not so fast.
Damage Limitation?
The extent of the damage isn’t clear as yet at major miners. The shares of Anglo, Rio and Glencore all trade in the region of 13x and 10x their forecast net earnings for 2015 and 2106, but they are not cheap enough in this environment.
It all started last year with the major players saying ‘we are selling assets to deliver shareholder value’. I’d argue that they were more preoccupied for their bondholder.
In a market where sellers did not dictate prices, buyers did not show up for their assets, of course, so now is the time to read about huge write-downs and massive cuts in operating costs — virtually any miner on the planet is implementing such a strategy at present. But if the commodity slump continues, valuations could get much lower… and some major miners — whose debts are meaningful — could run the risk of going out of business.
Bankruptcy is a remote possibility at Anglo, which will certainly find a partner even if its recently announced strategy doesn’t pay dividends. “We’re looking at every dollar and pulling everything back,” Anglo said last week when it announced a comprehensive corporate restructuring — “it is a constant process driving out costs,” its boss pointed out.
Rio Tinto and Glencore aren’t too bad, but there comes a point when dividend risk will have to be considered as a serious threat to value at both — as well as elsewhere across the mining sector.
Perhaps we are not there yet, but the yield that the shares of these companies offer — in many cases the dividend yield is well above 5% — is surely not sustainable in this environment. What’s encouraging, though, is that consolidation will likely come before significant dividend cuts are announced in the industry, and is a very likely outcome — particularly if stock prices of miners fall by another 30%/40% on the back of plunging profitability and bigger write-downs!
Hence, you’d do well to hunt for safer, less cyclical stocks that could deliver steady 20%+ annual returns over time — want to know how to achieve that performance?
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Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.