This Diversified Global Miner's Too Cheap to Ignore

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Softening demand for commodities, on the back of China's slowing economy, has hurt the profitability of all the major mining companies, creating a sentiment-fueled selloff of mining stocks. This has driven down the share prices of all the major miners, with the world's largest miner, BHP Billiton (NYSE: BHP) (NYSE: BBL) down by 29% for the year to date. Both diversified global miner Rio Tinto (NYSE:RIO) and Brazilian iron ore heavyweight Vale (NYSE:VALE), have also seen their share prices plunge to be down by 27% and % respectively. But BHP, a diversified miner global miner that can leverage significant economies of scale from its dominant market position, now appears oversold.  

One of BHP’s key strengths -- particularly in comparison to Vale, the world’s second-largest mining company -- is its diversified operations. These see BHP mining and selling a range of commodities, including petroleum, aluminum, base metals, and iron ore, as the chart below illustrates.

<table> <thead> <tr><th> <p><strong>Product</strong></p> </th><th> <p><strong>BHP Percentage of Revenue</strong></p> </th><th> <p><strong>Rio Percentage of Revenue</strong></p> </th><th> <p><strong>Vale Percentage of Revenue</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p><strong>Petroleum</strong></p> </td> <td> <p>21%</p> </td> <td> <p>0%</p> </td> <td> <p>0%</p> </td> </tr> <tr> <td> <p><strong>Aluminum</strong></p> </td> <td> <p>11%</p> </td> <td> <p>20%</p> </td> <td> <p>0%</p> </td> </tr> <tr> <td> <p><strong>Base Metals</strong></p> </td> <td> <p>19%</p> </td> <td> <p>13%</p> </td> <td> <p>16%</p> </td> </tr> <tr> <td> <p><strong>Diamonds</strong></p> </td> <td> <p>1%</p> </td> <td> <p>8%</p> </td> <td> <p>0%</p> </td> </tr> <tr> <td> <p><strong>Iron Ore</strong></p> </td> <td> <p>28%</p> </td> <td> <p>48%</p> </td> <td> <p>69%</p> </td> </tr> <tr> <td> <p><strong>Manganese</strong></p> </td> <td> <p>3%</p> </td> <td> <p>0%</p> </td> <td> <p>0%</p> </td> </tr> <tr> <td> <p><strong>Metallurgical Coal</strong></p> </td> <td> <p>9%</p> </td> <td> <p>0%</p> </td> <td> <p>2%</p> </td> </tr> <tr> <td> <p><strong>Energy Coal</strong></p> </td> <td> <p>8%</p> </td> <td> <p>11%</p> </td> <td> <p>0%</p> </td> </tr> <tr> <td> <p><strong>Fertilizers</strong></p> </td> <td> <p>0%</p> </td> <td> <p>0%</p> </td> <td> <p>7%</p> </td> </tr> <tr> <td> <p><strong>Logistics Services</strong></p> </td> <td> <p>0%</p> </td> <td> <p>0%</p> </td> <td> <p>4%</p> </td> </tr> </tbody> </table>

Source data: BHP Report for the half-year ended Dec. 31, 2012; Rio 2012 Annual Report; Vale Q1 2013 Financial Report.

Of the big three miners, BHP has the most diversified production, making it the least reliant on any one particular commodity such as iron ore to drive sales and profitability. As a result, BHP generates less than a third of its revenue from one of the hardest-hit commodities to date: iron ore. In contrast, Rio relies on iron ore to generate almost half its revenue, and Vale over two-thirds. The value of this diversified production base becomes even clearer when you consider that BHP generates a fifth of its revenue from petroleum, and another fifth from base metals, including gold and silver.

This allows BHP, unlike Vale or -- to a lesser extent -- Rio, to mitigate the risks that a declining iron ore price poses for its sales and profitability. This is an important point, because for the year to date, iron ore has already fallen by 28% to $114 per metric ton, and it is expected to fall farther. Furthermore, BHP is able to defray much of the political and economic risk associated with the mining industry, because the majority of its revenue is generated in the politically stable countries of Australia and the U.S.

Vale obtains the majority of its revenue from Brazil, where the government has shown a disturbing predilection to intervene in the economy, implement protectionist measures, and interfere in the business sector. In addition, Rio derives a considerable minority portion of its revenue from unstable frontier markets such as Mongolia and Mozambique.

BHP, like Rio, is also focusing on expanding its Australian operations allowing it to access greater economies of scale and reduce production costs per unit. Both it and Rio are also substantially closer to the primary market for commodities -- China -- when compared to Vale, thus reducing their shipping costs and times. As a result, BHP and Rio are far more competitive than Vale, and better equipped to cope with a prolonged downturn in iron ore prices.

BHP delivered some disappointing financial results for the first half of 2013, with net income down by 23% to $4 billion. But the company has significantly increased production in the second half of 2013, as a means of creating further economies of scale to drive down production costs per unit. For the year ending June 30, 2013, BHP reported that iron ore production increased by 7% year over year, while petroleum production was up 6% in the same period. Copper and metallurgical coal production also significantly increased during this period, up by 10% and 13% respectively. 

Foolish Bottom Line

Despite softening demand for commodities, and China’s economy waning, BHP is increasing production as a means of driving greater economies of scale. These will allow BHP to take further advantage of its diversified miniing operations and their close proximity to China as a means of cutting production costs and increasing sales, allowing the company to maintain its profitability.

This indicates that while softer commodity prices will continue to affect profitability, BHP is in a superior position to either Rio, or more specifically Vale, by virtue of its diversified and growing production. This also leaves the company better-positioned than either Rio or Vale to weather a prolonged downturn in commodity prices. 


Matt Smith has no position in any stocks mentioned. The Motley Fool owns shares of Companhia Vale Ads. 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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