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BHP beats RIO by a whisker

Posted By Paul Rickard On In Markets,Shares | No Comments

There aren’t too many ‘shrink to greatness’ success stories, so it was hard to get too excited by the RIO Investor Presentation last Tuesday. Invariably, when the subject of RIO comes up, the question most often asked is – “do I buy BHP or RIO”?

We think the answer is marginally in favour of BHP, and here is why.

Interestingly, over the course of 2013, there is very little difference in shareholder returns. BHP started the year at $37.10 and closed on Friday at $36.75. RIO, on the other hand, has risen from $66.01 to $66.41. BHP has paid higher dividends, so its all up return is 2.29%, compared to 3.40% for RIO. Nothing to get too excited about, although both are better than the Materials Accumulation Index, which shows a negative return of -4.59% this calendar year.

So what about 2014?

RIO – shrinking to greatness?

The market liked the RIO briefing, which basically put growth on the back-burner. Cash will now be used in order of priority for essentially sustaining capex, then progressive dividends and in third place, debt reduction or “compelling” growth.

Key priorities for the group are lowering operating costs, reducing exploration spending, completing existing projects, progressing non-core asset disposals and increasing the dividend. Exciting stuff.

You also wonder which consulting firm designed this powerpoint below, as this “strategy” slide could arguably be applied by dozens of mining companies:

A consistent strategy with clear priorities

Source: RIO Investor Presentation, 3 December 2013

Importantly, RIO remains largely an iron ore miner, with a somewhat problematic copper division and some other bits (such as aluminium) that it really doesn’t want. This means that it potentially has great leverage to the iron ore price, however it also carries greater risk.

RIO EBITDA (1st Half 2013)

Source: RIO Tinto

BHP – diversification brings strength

BHP, with its “four key pillars of coal, copper, iron ore and petroleum, and a possible fifth pillar in potash” (as stated by Jac Nasser, Chairman, at the AGM in November), sees its diversified strategy as its key strength, making it less vulnerable to specific commodity risks. Further, the portfolio potentially gears BHP to both investment and consumption-led economies, with its exposure to steel making, metals, energy and food.

While BHP is more diversified than RIO, iron ore is still a major driver of EBIT:

BHP EBITDA FY 13

Source: BHP

Like RIO, BHP is also focussed on reducing costs (claiming US$2.7bn in controllable and sustainable annualised cost savings in 2013), and has cut back on capital expenditure, with this reducing by 25% to US$16bn for the 2014 FY. BHP has a major focus on boosting productivity from existing operations, and in 2013, delivered volume increases in all businesses except nickel.

Source: BHP Annual General Meeting

The broker analysts go for RIO

According to the broker analysts surveyed by FN Arena, they see more upside in RIO’s share price from current levels (a target price of $79.21) than they do for BHP. While they are bullish on both companies, RIO has the highest average ‘sentiment’ indicator of +1.0 (+1.0 is a buy/outperform/overweight; -1.0 is a sell/underperform/underweight).

BHP by a whisker

While the market seems pretty much of the opinion that it is RIO over BHP, our sense is that BHP remains a better play from an investment point of view. Both companies are essentially pursuing similar strategies in reducing operating costs, improving productivity, and a more focussed approach to capital expenditure – although RIO seems to be putting growth on the backburner.

So, what tilts it in favour of BHP? We prefer BHP’s broader mix of commodities and the strength (and lower risk) from its diversification strategy, the longer-term opportunity in potash and food, the higher dividend and, historically, it has demonstrated a better track record in delivering shareholder returns. There is also an argument that if you are mainly after exposure to iron ore, Fortescue offers a better “pure-play” exposure than does RIO. On a risk/return basis, BHP gets the nod.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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