Times are a-changin' for global miners.
Glencore and Xstrata's proposed $90 billion tie-up will bring a unique model to the sector, combining mining with commodities trading. In truth, the world's biggest mining companies are already following divergent paths, from BHP Billiton's investment in shale gas and potash, to Rio Tinto and Vale's single-commodity focus. The question for investors is which model offers the most reliable returns.
Risks for miners are certainly accumulating. A hard landing for the Chinese economy would hit commodity prices hard, particularly iron ore, where China accounts for 60% of global demand. High energy and salary costs are eating into margins. Governments are also targeting the sector: The threat of outright mine nationalization lingers in places such as South Africa and Mongolia.
Against this backdrop, BHP Billiton's model is the most defensive, given its focus on a few major projects across a range of commodities in politically stable countries. Its problem lies in matching some investors' hopes for short-term returns against its desire for a portfolio to satisfy long-term commodity demand.
For example BHP's large investment in U.S. shale gas may not see a positive return before 2020 if gas prices remain subdued, HSBC estimates. BHP's heavy capital-expenditure program means its free cash flow yield could trail its peers by next year, limiting scope for higher dividends or share buybacks, according to brokerage Jefferies.
Still, BHP's balance between risk and reward looks attractive relative to its rivals. At 8.8 times expected 2012 earnings, the shares trade more cheaply than all but those of Rio Tinto and Brazil's Vale, according to FactSet. Yet Rio relies on one Australian iron-ore mine for 70% of its earnings. Vale is even more concentrated on iron ore; it accounts for more than 90% of its operating profit.
True, Anglo American is more diversified, but its political risk is higher, with around 40% of earnings generated from assets in South Africa. Glencore-Xstrata, meanwhile, is likely to grow more through acquisition. But that could take it into lower-quality assets in politically risky areas; claims that Glencore's trading arm will enhance and smooth earnings remain unproven.
Merger mania may have brought near-term excitement to the mining sector. But for investors with a longer horizon, BHP Billiton still looks a keeper.
Source: http://online.wsj.com/article/SB10001424052970204062704577222902312816094.html?mod=WSJ_Heard_LEFTTopNews
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