2 Miners To Consider Now, 3 To Avoid

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

Many mining ventures face challenges working with local governments and working inside of local regulations. Yes, we live in a global world, but our legal and regulatory institutions are local. Ultimately, mining is very sensitive to parochial government since miners cannot leave and take their mines with them.

Based on this risk and others, investors should only invest in miners at attractive valuation multiples.

India Miners Shut Down

India’s Supreme Court imposed a ban on mining in the state of Goa affecting 93 mines after an investigation revealed that mining had contaminated ground water and encouraged illegal logging. The mining ban, the second one after a similar ban was imposed in southern Karnataka in 2011, is eroding India’s credibility as a supplier, putting pressures on ore prices and giving opportunities to mining companies like BHP Billiton (NYSE: BHP) and Rio Tinto (NYSE: RIO), two of Australia’s biggest iron ore exporters to China. Spot iron ore prices at China’s Tianjin port shot up 67% to $144.90 per ton as of December 31. Nomura Holdings’ Managing Director David Radclyffe said, “The drop in supplies from India has tightened the market and provides support to iron ore prices.  Because of uncertainties in India, low-cost miners like Rio are clearly finding a bigger market share.”

Apparently, Australia has been filling up the slack left by India’s suppliers, supplying 47% of China’s imports up from 43% in 2011, while India’s share declined to 4.9% from 11% last year as shown by data from Bloomberg.

India’s political climate has prompted its judicial system to lean towards activism as a response to the various corruption scandals in Prime Minister Manmohan Singh’s government.  Following a state auditor’s report stating that the government may have foregone $31 billion in revenues after allocating airwaves without an auction, the Supreme Court stripped phone operators of 122 licenses in February.  The Federation of Indian Chambers of Commerce and Industry former head Rajiv Kumar said, “We are seeing a rise in judicial activism in India because the government’s regulatory oversight is compromised and the industry does not adopt any initiative for self-regulation.  We have to find the right balance between growth and sustainable industrial practices.”

An inquiry appointed by the Federal Mines Ministry revealed that companies in Goa illegally mined and exported ore worth about 350 billion rupees ($6.4 billion) but the companies deny the charges.  India’s Supreme Court will resume hearing Goa’s government plea to lift the ban this January, with the case expected to last for more than a year like what happened to the Karnataka state’s ban.

The Justice M.B. Shah Commission of Inquiry has expanded its probe, surveying mines in Odisha, where the concerned authorities stopped issuance of transport permits for mines producing ore for trading, resulting in work stoppages and supply shortages. The bans are forcing iron resource rich-India to import the material, estimated at five million tons for 2012.

This is good news for competing iron-ore miners, but it is also a warning. At any moment a mining operation could be shut down. Regardless of the merits or justification for a shutdown, a company cannot move its mine.

Stifling Regulations

Gulf Oil (GULF) is likely to exit the mining in India because of restrictions imposed by the Indian government. Gulf Oil’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.”

Congo Government Wants 35% of Mine Projects in Code Changes

Governments often lean on mining operation since miners cannot relocate to other jurisdictions.

The Democratic Republic of Congo business association relayed the news of how the government is planning a 5 to 35% increase in government participation 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 appropriation.

Cliffs Cuts Iron Production

Beyond government confiscation, simple market risk confronts commodity producers.

Cliffs Natural Resources (NYSE: CLF) announced it will lay off about 625 staff from projects in Quebec, Michigan, and Minnesota because of declining iron ore demand. Its Empire Mine in Palmer, Michigan will suffer a layoff of five hundred jobs. Cliffs Natural Resources is also postponing its planned 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 largest iron-ore company, Vale (NYSE: VALE), is being managed responsibly in response to weak demand for building materials. Vale 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 some of its stake in its potash project in Argentina and its Moatize coal project in Mozambique. 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

Investors should demand low valuations for miners. Not all of them are priced low enough to make them compelling:

<table> <tbody> <tr> <td> <p><strong><span>Ticker</span></strong></p> </td> <td> <p><strong><span>Company</span></strong></p> </td> <td> <p><strong><span>P/E</span></strong></p> </td> <td> <p><strong><span>P/S</span></strong></p> </td> <td> <p><strong><span>P/B</span></strong></p> </td> <td> <p><strong><span>D/E</span></strong></p> </td> </tr> <tr> <td> <p><span>BHP</span></p> </td> <td> <p><span>BHP Billiton</span></p> </td> <td> <p><span>13.76</span></p> </td> <td> <p><span>2.93</span></p> </td> <td> <p><span>1.94</span></p> </td> <td> <p><span>0.43</span></p> </td> </tr> <tr> <td> <p><span>RIO</span></p> </td> <td> <p><span>Rio Tinto</span></p> </td> <td> <p><span>26.02</span></p> </td> <td> <p><span>1.89</span></p> </td> <td> <p><span>1.93</span></p> </td> <td> <p><span>0.38</span></p> </td> </tr> <tr> <td> <p><span>TCK</span></p> </td> <td> <p><span>Teck Resources</span></p> </td> <td> <p><span>17.08</span></p> </td> <td> <p><span>2.07</span></p> </td> <td> <p><span>1.23</span></p> </td> <td> <p><span>0.43</span></p> </td> </tr> <tr> <td> <p><span>VALE</span></p> </td> <td> <p><span>Vale</span></p> </td> <td> <p><span>8.53</span></p> </td> <td> <p><span>2.26</span></p> </td> <td> <p><span>1.32</span></p> </td> <td> <p><span>0.38</span></p> </td> </tr> <tr> <td> <p><span>CLF</span></p> </td> <td> <p><span>Cliffs Natural Resources</span></p> </td> <td> <p><span>5.86</span></p> </td> <td> <p><span>0.89</span></p> </td> <td> <p><span>0.84</span></p> </td> <td> <p><span>0.61</span></p> </td> </tr> </tbody> </table>

BHP Billiton, Rio Tinto, and Teck Resources (NYSE: TCK) are too expensive to warrant jumping into mining. Cliffs Natural Resources and Vale are cheap enough to lure disciplined investors into commodity stocks. Investors should consider Cliffs Natural Resources and Vale as speculative bets due to their low price multiples and smart management which is not afraid to shut down projects during periods of declining demand.


BillEdson11 has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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