Are 5 Mining Stocks Worth The Risk?

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Mining companies are often intimately connected to emerging economies and challenges associated with operating and selling to these markets. In addition to this connection to demand from developing and emerging markets, base metal miners must also deal with issues that arise from overseas operations. As it turns out, once you develop a mining project, it is hard for you to move it out of the country. This means that governments and other regional forces can demand significant compensation from mining companies. Mining operations can become targets either when they are trying to sell materials or when they are mining ore from the ground.

In light of these risks, investors should only invest in miners at attractive valuation multiples.

RIO Pays for China’s Good Graces

Rio Tinto (NYSE: RIO) is seeking better fortune through purchasing and displaying a jade horse in its company office in China. China is the company’s largest market and it needs to grow the business in this country. The company’s China managing director, Ian Bauert, noted “When we designed this office, we asked a Feng Shui master to give us some guidance and he advised to have a Jade horse in a pool of water. So the good Qi comes in, the good spirit comes in to recirculate and makes us a prosperous and happy company in China.” Rio lost its top position to arch-rival BHP Billiton (NYSE: BHP) in 2009.  Even though the company recorded sales growth of 72 percent to $19.5 billion in the past three years in China, this growth was less than the growth of BHP Billiton.

The company is facing tough competition from other big players like BHP Billiton and Vale (NYSE: VALE). A chief analyst with researcher Mysteel.com, Xu Xiangchun said, “Competition for Chinese market share is getting fiercer.” He also feels that the relationship between the Chinese government and these mining companies will be crucial for growth in these companies.

Stifling Regulations

The alternative to strengthening relationships through bribes, donations, and other non-business activity is to just shut down operations. Gulf Oil (NASDAQ: GULF) is most likely to exit the mining business because of restrictions imposed by the Indian government. Their services are extracting coal, iron ore and minerals. The company’s Managing Director Subhas S. Pramanik said, “The Company may also consider separating the division into a subsidiary. We are tired of waiting for government policy on mining to change. We are idling so much of our machinery and people.”

Analysts say that exiting this mining unit will help the company to concentrate on selling industrial lubricants. Gulf Oil’s acquisition of Houghton for $1.05 billion has helped the company get a good grip on the lubricants business. India-based executive director at PricewaterhouseCoopers Mohit Chopra said, “Houghton’s purchase will help Gulf Oil expand from supplying lubricants only to automobile companies, which are experiencing a slowdown in growth.” He also believes that lubricants will account for nearly 90% of the total revenues of this company. On the other hand, the company’s explosives business, which accounts for 23 percent of sales, is in a downtrend.

Congo Government Wants 35% of Mine Projects in Code Changes

Governments often lean on mining operations. After all, it’s not like miners can relocate hundreds or thousands of miles away.

The Democratic Republic of Congo business association revealed that the government is planning a five percent to thirty-five percent increase in government involvement in mining. It also plans to increase the amount of royalties that is charged on mineral exports. It remains to be seen how much of these changes will amount to legitimate partnering with miners and how much is simply wealth confiscation.

Cliffs Cuts Iron Production

Beyond government confiscation, simple market risk confronts commodity producers.

Due to poor iron demand, Cliffs Natural Resources (NYSE: CLF) announced it will lay off about 625 staff from projects in Quebec, Michigan, and Minnesota. Five hundred jobs will be slashed from its Empire Mine in Palmer, Michigan. The company is also postponing the expansion of its Bloom Lake mine in Quebec.

Sandy Karnowski, a spokeswoman for Cliffs, said, "It's a tough day for all of us at Cliffs and we're hopeful to see the market conditions improve in the future.”

Vale Controls Costs

The world’s biggest iron-ore company, Vale, seems to be reacting responsibly to weak demand for building materials. The company is delaying some of the company’s biggest projects. Vale stated, “We will conclude projects already under execution, while research and development expenditures are being cut to give rise in the future to a smaller and more select portfolio of projects. 2012 is very likely to be the peak year for capital expenditures in the foreseeable future.”

Vale is also looking to sell ownership in its potash project in Argentina and its Moatize coal project in Mozambique. Vale’s CFO Luciano Siani said, “The decision has been made but we are still exploring the market to see what’s the possibility to realize value on the sale as well, we are not going to fire sale any asset.”

This prudent change in strategy is an intelligent response to falling commodity prices.

Valuation

Given the macro picture, investors should demand low valuations for miners. Many large cap miners are not priced low enough

Ticker

Company

P/E

P/S

P/B

D/E

BHP

BHP Billiton

12.49

2.66

1.76

0.43

RIO

Rio Tinto

22.23

1.62

1.65

0.38

TCK

Teck Resources

15.24

1.86

1.1

0.43

VALE

Vale

7.06

1.87

1.09

0.38

CLF

Cliffs Natural Resources

4.49

0.68

0.65

0.61

Cliffs and Vale are cheap based on valuation, while the remaining companies on this list are too pricey based on valuation for commodity companies. Investors should consider Cliffs and Value as speculative plays based on low price multiples and smart management which is not afraid to shut down projects during periods of declining demand.


BillEdson11 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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