Australian Miners Have Global Reach
Daniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I recently discussed the ongoing economic boom in Australia, driven by the export of the country's natural resources. More than any others, two Australian companies have been behind the nation's strong performance: BHP Billiton (NYSE: BHP) and Rio Tinto (NYSE: RIO). The two are amongst the largest diversified miners in the world, along with Vale (NYSE: VALE) and Anglo American (PINK: AAUKY). Besides their Aussie heritage, the two firms have a lot in common that make them both attractive investments.
Each company benefits enormously from size and scale, allowing them to weather the downturns in their highly cyclical business. Unlike competitors who concentrate operations in the developing world, both firms limit their political risk by earning most of their revenue from stable, mature economies in North America, Europe, and Australia. Both companies have global operations that allow them to minimize transportation costs to markets. Each has a stellar record of adding value through shrewd acquisitions, which will become increasingly important as ongoing consolidation gives major producers more pricing power. Both have a deep inventory of high-quality assets running below capacity, giving them the power to make incremental investments in production. Other miners are forced to make massive, all-or-nothing expenditures to develop new mines. They each have long time horizons, with a typical planning period for a new project around 20 years.
And by deploying all these advantages, they have one final commonality: over time, both have produced market-beating returns for shareholders. Since the inception of the Dow Jones Global Basic Materials Index in 1999, BHP and Rio Tinto have racked up impressive scores over their sector index and the broad market:
The major difference between the firms is BHP Billiton's exposure to oil & gas. BHP's petroleum operations are global, but production is concentrated in shale and deep water operations in Australia and North America. Petroleum accounted for about a fifth of BHP's earnings before interest and taxes in 2011. This added diversification further insulates BHP Billiton from the vagaries of any single commodity market. However, it also trades at a premium to Rio Tinto, sporting a price to book ratio of 2.7 to Rio Tinto's 1.6
China: Customer Today, Competitor Tomorrow
While BHP Billiton and Rio Tinto have gotten rich selling basic materials to China, trends in that country are worrying. First, the Chinese government has been proactive in attempting to secure its own supplies of essential resources, and state-owned enterprises are quickly rising to become serious competitors. While so far Chinese firms have been slow to enter the critical iron market, enterprises like Shenhua Group, China Coal, and Zijin Mining are already some of the largest producers of non-ferrous mining products in the world. There is every reason to expect that eventually China will seek to consolidate its iron supply under state-owned enterprises.
Further, even though China consumes fewer basic materials per capita than developed nations, due to its vast population it is currently the largest consumer of metals on earth. As economic growth begins to slow, demand from China will be sluggish regardless of whether private companies or state-owned enterprises are meeting that demand. Both of these trends indicate that to prosper, Rio Tinto and BHP will need to diversify not just their production, but their customer base.
The Rise of Africa
China is not the only nation that is seeing millions of people lifted out of poverty. India is an obvious candidate for increased future metal demand, but that nation's economy has been called “the next China” for many years, and seems to have a gift for perpetual disappointment. Instead, I look to the astonishing economic progress being made in Africa. In 2011, Ghana's GDP grew by 13.5%, leaving China in the dust at 9.5%. This mirrors a broad trend of rapid improvement in sub-Saharan Africa, hinting that at last the economies of that region are reaching escape velocity. The IMF expects the region to maintain aggregate growth of 5% for many years, with some performers, like Ghana, Kenya, and Uganda expected to far surpass that. With a population set to surpass one billion, the rise of Africa should provide strong demand growth in metals for decades to come.
In the short term, I don't expect rising demand from Africa, India, or Latin America to compensate for the cooling of the Chinese economy, and I wouldn't be surprised to see shares of the miners lose value. Over the next few years, we will enter a lull in between China's demand slowing and Africa's demand accelerating. For investors as optimistic about the state of the world as I am, this lull will present an excellent buying opportunity to own a piece of the companies that will provide the basic materials for a new economic miracle.
Daniel Ferry owns shares of Rio Tinto plc (ADR). 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. If you have questions about this post or the Fool’s blog network, click here for information.