Miners: The Good, The Bad & The Ugly
Ken is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Base metals should enjoy rising prices as the global economy is fueled by the creation of new money from the central banks. This will create opportunities for enormous profits in the base metals sector but only if investments are chosen wisely. However, one must keep in mind not all miners are created equal.
There are a lot of companies in the mining business but very few of those around today will still be around in 10 years. If you are going to invest in this arena, you must find the businesses that will be around. It is a simple fact that most natural resource companies are far better at promoting their stock price and issuing new shares than they are at actually making a profit. However, that does not mean substantial profits can’t be made within a very reasonable risk/reward structure; it simply requires a careful analysis of the numbers. In the mining business, I look for large, profitable operations with a long history of success that are trading below what I estimate to be the fair value of the business.
For me, the most surprising result of my analysis was Newmont Mining Corporation (NYSE: NEM). Newmont is mostly known as a gold mining business and, while it does produce some other metals, that is its main purpose. Normally, I don’t find great opportunities within the gold mining sector that present a risk/reward scenario that meets my criteria for investment. Today, Newmont might just be an exception. It sports a current year P/E of 10.56 and a forward P/E of only 7.72 with a projected price to cash flow of 6. These numbers border on compelling!
At the current price, the dividend yield is a healthy 4.25% with a reasonable payout ratio of 36%. The debt/equity ratio of 0.46 is a bit high but not to the point of being alarming considering the capital intensive nature of the industry. With an average P/E ratio in the gold mining industry of 19.8, Newmont appears to be a company with very good potential for share price appreciation and the solid dividend makes the wait worthwhile. The share price could double from here and be only slightly higher than the industry average.
Freeport McMoRan Copper and Gold (NYSE: FCX) is the big dog of copper miners. With a market cap of $31.41 billion and ownership of the largest developed copper mine in the world, it is a formidable force in the mining industry. Freeport’s stock was seriously punished last year when it announced plans to acquire Plains Exploration and Production Company and McMorRan Exploration and the market viewed the plan with disfavor. While this might not have been the best deal possible for Freeport, as is often the case for acquiring companies, investors sold massive amounts of shares in a panic and the price fell to a very undervalued level.
At the current market price, Freeport can be purchased at 10.34 times current year earnings and only 6.81 times next year’s. The industry average P/E is 13, so Freeport’s share price could double from here and only be equal to the industry average. It boasts a dividend yield of 3.81% with a very reasonable payout ratio of 39%. For a mining industry stock, the debt to equity ratio of 0.20 is exceptional.
BHP Billiton (NYSE: BHP) trades as an ADR and is an Australian based mining company, originally started in Broken Hill, NSW. It has grown to become a global powerhouse in the natural resources and resource products industries. It has a market capitalization of $196.55 billion and offers a quite attractive, safe dividend yield of 3.09%. With a current price to earnings multiple of 12.8, a forward multiple of 12.12 and a published price to cash flow of 11.1, it is fairly valued as well. Unfortunately, fairly valued doesn’t really offer a great opportunity for profit unless prices for the products rise and costs are contained. Companies that are slow growing and fairly valued make bad investments in my mind as they don’t offer enough opportunity for profit. A 3% dividend alone does not justify my investment.
Southern Copper (NYSE: SCCO) caught my eye with its hefty 9.95% dividend yield until I looked at the numbers and saw that it appears they could be taking on debt to fund part of the dividend. In addition, based on a market cap of 14.4 times cash flow, current price to earnings ratio of 16.48 and a forward price to earnings ratio of 13.4, this is not a cheap stock and I have serious questions regarding the stability of their dividend. For those who care about such things, there are 8 analysts covering the stock; five rate it as a “hold” and three rate it as a “strong sell.” Without regard to those opinions, this stock just seems to be priced too high, given my concerns over the dividend. Should the company be forced to reduce the dividend, the share price would be punished severely. With a debt/equity ratio of 0.88, there is just too much risk here for my taste.
In closing, as global economic activity increases, demand for base metals will rise. Newmont Mining and Freeport McMorRan appear to be stocks that offer exceptional value at the current prices and will provide a nice, steady flow of dividend income while shareholders wait for the coming capital gains.
Ken McGaha has no position in any stocks mentioned. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. 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!