A High-Yielding Industrial Giant for Your Portfolio

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

Emerging countries including India, China and Brazil are expected to grow at a rapid pace. Their rising industrial production, coupled with the recovering US economy, present a bullish case for industrial plays. Their respective governments are trying hard to revive their growth engines, and their trade policy easing is attracting a lot of foreign investments. Moreover, China’s $156 billion infrastructure spending plan will further pump up infrastructure activity, which makes companies like Vale (NYSE: VALE), BHP Billiton (NYSE: BHP) and Cliffs Natural Resources (NYSE: CLF) appear all the more attractive.

Reasons to Buy Vale

Vale is the world’s largest producer of iron ore, and it accounts for nearly 25% of the global iron ore supply. Talking about its coal segment, the company was losing margins on overseas shipments, so it expanded in Africa (Moatize mine). But it in November, its management cut the FY13 coal production target for the mine by 50% (2.6 million tonnes), due to the limited railroad transportation capacity.

However, the management also said that it expects 5 million tonnes of coal exports in the next year, once the upgrade and construction work on Sena Railway Line is complete. Upon completion, the railway line would be able to carry up to 6.5 million tonnes of coal annually, up by 2 million tonnes. This also leaves some headroom to ramp up its production.

The company also has an asset divestment program under way. According to the management, this would help the company to realign itself with its long-term goals, and allow it focus on its core competencies. The details of the divestment program were not revealed, but the management assured investors that it is well aware of its assets’ valuations, and there won’t be a fire sale to raise money.

On Feb. 6, Silver Wheaton announced that it has entered in a binding agreement with Vale, under which Silver Wheaton will acquire its gold mines in Brazil and Sudbury. For the 20-year agreement, Vale would receive $1.9 billion in cash and 10 million Silver Wheaton warrant with a strike price of $65. Since the fears of a fiscal cliff are behind us, and major economies around the globe are showing signs of recovery, gold is expected to lose its lustre. Thus I believe that such divestments are good for Vale.

Reasons to Miss the Peers

But having positive catalysts is not enough. Examining the fundamentals is also important, as they give an insight to the company’s financial health. Here are the financial metrics of Vale, BHP Billiton and Cliffs Natural Resources.

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Forward P/E</p> </td> <td> <p>Net Profit Margin</p> </td> <td> <p>Debt/Equity</p> </td> <td> <p>Yield</p> </td> </tr> <tr> <td> <p>Vale</p> </td> <td> <p>8.6x</p> </td> <td> <p>24.53%</p> </td> <td> <p>38%</p> </td> <td> <p>3.13%</p> </td> </tr> <tr> <td> <p>BHP Billiton</p> </td> <td> <p>18.27x</p> </td> <td> <p>21.50%</p> </td> <td> <p>43%</p> </td> <td> <p>2.84%</p> </td> </tr> <tr> <td> <p>Cliffs Natural Resources</p> </td> <td> <p>9.36x</p> </td> <td> <p>16.28%</p> </td> <td> <p>61%</p> </td> <td> <p>8.48%</p> </td> </tr> </tbody> </table>

Leaving aside the dividend yield, Vale clearly steals the show. Amongst the three, it’s not only the most undervalued stock, but also enjoys the highest net margins, with the lowest debt/equity ratio. Moreover analysts estimate its EPS to grow by nearly 16% over the next year. The reason Cliffs Natural Resources misses out is that its payout ratio is a modest 28% while its yield is massive. Its shares have lost nearly 60% of their value over the last year, which has artificially boosted its yield. BHP Billiton however, isn’t undervalued and its metrics don’t reveal anything compelling to buy it at high valuations.

There’s another peer, Sterlite Industries (NYSE: SSLT), which is an Indian mining company. Its production took a hit when the Supreme Court of India imposed a ban on the operations of 90 mines in Goa. The state alone has the capacity to produce 50 million tonnes of iron ore annually, and to meet up with the shortfall of supply, the Indian government is looking to impose a ban on iron ore exports. This is definitely not good for mining plays like Sterlite Industries.


I believe that Indian-based Sterlite Industries would underperform the market, due to government policies and bureaucratic loops. Vale however has its share of positive catalysts, and strong fundamentals to ensure healthy growth. BHP Billiton looks overvalued, while Cliffs Natural Resources has been losing value continuously. To wrap it up, Vale appears to be the best investment option available.

PiyushArora has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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