Proven Profits in Tough Times, Explosive Gains to Come

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

The mining industry can be a risky place to invest, since it is prone to great volatility and tremendous boom and bust cycles. However, those investors who select businesses that can maintain profitability in tough conditions can make a fortune when commodity markets strengthen. By selecting strong businesses whose shares have been punished alongside their weaker counterparts yet continue to pay solid dividends, prudent investors can not only enjoy the fabulous upside potential that exists in the mining sector, but also get paid handsomely while they wait for prices to increase.

Fortunately, investors today don’t have to dig deep to find opportunities for great income and future capital gains. They just have to take a look at the beaten down shares of some of the world’s best mining companies with proven assets and track records of profitable performance.

High yield/low priced base metals

While gold and silver miners tend to get a great deal of exposure in the media, the world economy can’t function without the production of the much less glamorous base metals: iron ore, manganese, nickel copper aluminum and ferroalloys. In addition to those, the world needs potash phosphate and nitrogen to provide the fertilizer required to produce healthy, high-yield agricultural products necessary maintain our food supply.

Brazil-based Vale (NYSE: VALE) provides all of these products to their customers and can also help with the logistic services required to get them delivered. Even though the global economy has experienced several tough years, Vale has rewarded shareholders with a dividend that has grown at an annualized rate of 24.23% over the past five years--yet it is valued at only 6.75 times this year’s projected earnings and only 7.5 times cash flow.

While the past and current valuation metrics are favorable for Vale, investing is about how a business is projected to perform in the future: analysts’ consensus earnings growth rate for the next five years is 21.7%, which is huge when you consider the current P/E of 6.75. In addition to that surprisingly low valuation to growth, the business has delivered an average 21.8% return on equity to shareholders for the last 5 years as well. With net margins holding a five-year average of 28.7%, this is a profitable, growing business with a low valuation and exceptional prospects, supplying the world with products it must have. While shareholders wait for the capital gains that will come from a rising stock price, which will be driven by higher prices for base metals and fertilizers needed for commercial and agricultural use, they will be rewarded with a very generous dividend of 5.65%.

The epitome of an industrial metal from a trophy property

When investors are given the opportunity to acquire one of the most productive mining properties in the world for a bargain basement price it is always wise to act quickly as those conditions tend to rectify themselves quickly. The current market valuation of Freeport-McMoRan (NYSE: FCX) provides those willing to act soon with such a proposition.

Many people believe that copper prices can predict economic activity. As the global economy grows, Freeport McMoRan is a mining business positioned to prosper, as it produces copper and gold from what many believe to be the world’s most valuable copper mine: the Grasberg Mine located in Indonesia. While it has a plethora of other producing properties, Grasberg is the true trophy in the Freeport portfolio. With a valuation of only 5.8 times free cash flow, interest coverage for its debt of 29.8 times, and a dividend yield of 4.04%, this business includes one of the world’s most productive mines yet trades as if it were a speculative investment.

Rising standards of living in the emerging economies will drive demand for raw copper and rising demand for any commodity results in rising prices. Freeport McMoRan will be one of the primary beneficiaries of those rising prices and they have a proven track record of rewarding shareholders as represented by the 5-year dividend growth rate of 12.7%.

Better than just gold

One of the criticisms I hear about gold on a regular basis is that it doesn’t produce any income. Those who like to throw around that comment loosely have obviously never taken a close look at Newmont Mining (NYSE: NEM); a $16.8 billion market capitalization gold miner with a 4.1% dividend yield that has grown at a torrid 28.47% rate for the last 5 years.

Sitting on an asset base of 99.2 million ounces of attributable and probable gold reserves with a production cost in 2012 of $677/ounce, Newmont is maintaining attractive levels of profitability even after the recent pullback in gold prices, but its share price has been decimated, falling from a 52-week high of $57.93 to a recent low of $30.30. It has since rebounded to $34.11, at which price it is just plain cheap for a gold mining stock, at 9.08 times 2014 consensus earnings. Furthermore, based on the current outstanding shares, each share of Newmont represents 0.2 ounces of gold reserves, a value of $124.60/share based on a $1,300/ounce gold price and the 2012 production cost of $677/ounce.

Final thoughts and actions

All three of these businesses currently offer investors exceptionally favorable valuations with proven ability to remain profitable under adverse conditions and track records of rewarding their shareholders through high yielding dividends. As demand for their products grows and profits rise, the share prices of these businesses will follow and reward the owners with substantial capital gains to go along with the rich dividends they will receive while waiting. Investors who make equal investments in each of these three businesses will acquire a reasonably diverse selection of commodities stocks that should all benefit from improving economic conditions and rising standards of living as the latest economic uptrend continues to develop.

After putting together a blockbuster deal to expand into the oil and natural gas industry, Freeport-McMoRan will have plenty on its plate as it tries to adapt to the new industry, as expanding into oil and gas carries plenty of inherent volatility. FCX had a profitable copper business, and on top of this foray into a new industry it still has to contend with mining industry bellwether BHP Billiton. To help investors determine if Freeport-McMoRan is a buy or a sell, The Motley Fool has compiled a premium research report on the company. Simply click here now to access your copy today.


Ken McGaha has no position in any stocks mentioned. The Motley Fool owns shares of Companhia Vale Ads and 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!

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