Digging Profits Out Of The Mining Industry Collapse

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

The recent collapse of stock prices in the mining sector presents investors who act now with an opportunity to collect solid double-digit annual gains for years to come. Even better, those who choose wisely can also collect generous dividend yields while waiting for these world-class mining businesses to return to fair value.

Mining supplies the basic foundation of our lives

Copper wiring brings electricity into our homes and delivers it to the appliances within that we depend upon to provide us with the conveniences we now take for granted. Iron ore is a base component in the production of steel that is used to construct the cars we drive and the planes in which we fly. Potash is a major component in the fertilizers we use to increase crop yields and provide ourselves with adequate food supplies to feed a growing population. 

All of these base materials are supplied to the market by the global mining industry. When the global demand is strong and prices are high, all of the producers prosper; when prices fall, the weak players crumble, the strong businesses survive, and the stock prices of all competitors in sector get crushed.

Investors who buy shares of the obvious survivors during the weak periods are always richly rewarded when the inevitable uptrend occurs. Here are three picks that present excellent values for investors today, and pay handsome dividends while we wait for big gains in their stock prices.

Large size with the strength of steel

Brazil-based Vale (NYSE: VALE) is the world’s largest producer of iron ore -- the key base ingredient in the manufacture of steel -- and the second-largest producer of nickel. It also produces kaolin, a clay type substance used as a pigment in paint and a filler material in the manufacture of rubber and plastics, and potash, used in the manufacturing of fertilizer.

Over the past 52 weeks, Vale’s stock price has traded as high as $21.88 and currently sits almost 40% below that level at $13.15. The price to earnings ratio for 2013 is projected at a paltry multiple of 6.23. Considering the analysts’ consensus annual earnings growth rate projection of 20.2% for the next five years, the current P/E is difficult to explain from a fundamental perspective.

The strong dividend yield of 5.68% further enhances the attractiveness of this stock, and it requires only 32.76% of the income produced by the business to support it. Given its key role in supplying vital components to the steel and agricultural industries, Vale offers a compelling investment opportunity at the current valuation.

Own the largest resource on earth

While Freeport-McMorRan (NYSE: FCX) is most widely known for its operations in the Grasberg Minerals District, home to the largest known recoverable resource of gold and copper in the world, far fewer investors know how broadly diversified its copper resources are.

An estimated 34% of Freeport’s 119.7 billion pounds of proven copper reserves are located in North America, and another 33% are found in South Africa. With total holding of an estimated 33.9 million ounces of gold and 3.42 pounds of molybdenum added to its copper reserves, this is one resource-rich business. Better yet, it is currently priced very cheaply.

With a P/E multiple of only 7.2 times projected 2014 earnings and a current year’s price-to-cash flow multiple of 6.92 in a depressed metals market, this is a business and a stock poised to soar at the first sign of rising prices for base metals.

The current consensus earnings growth rate for the next five years is 17.6% per year, meaning the stock price could double and still carry a price to earnings growth ratio of less than one. By collecting the 4.58% dividend, investors will receive an attractive income stream, rewarding them for their patience while they wait for an improving global economy to raise demand and prices for base metals.

In mining, sometimes you have to dig a little

In the mining business, the numbers that appear on the surface don’t always reflect the whole story. Southern Copper (NYSE: SCCO) is primarily engaged in the mining and smelting of copper, silver, zinc and, molybdenum in Peru and Mexico. It appears to be trading at a reasonably attractive valuation of 12.97 times this year’s consensus earnings estimates, and it pays a reasonable dividend yield of 2.9%. However, when this P/E is compared against the valuations of Vale and Freeport, we see that it is twice the level of similar businesses, and the dividend yield is also significantly lower.

The projected earnings growth rate for Southern Copper is 11.6% annually for the next five years. That would make the current price approximately equal to a fair market value, considering it is in line with the projected growth rate going forward. In addition, the price-to-cash flow ratio of 12.45 times is about twice the value currently assigned to other world-class mining operators.

Final thoughts

Investors in any of these three businesses should expect to enjoy favorable results as the global economy continues to improve, driving demand for the base materials these businesses produce. However, considering the far lower valuations currently applied to Freeport and Vale, these two businesses appear to offer far more compelling opportunities than Southern Copper.

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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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