BHP And Rio: Buy More Or Dump Them?

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By Peter Switzer, Switzer Super Report

Anyone who has put a portfolio together in recent times would have to have some exposure to BHP-Billiton ((BHP)) and Rio Tinto ((RIO))  and would probably be pretty worried as iron ore prices head down, dragging their respective share prices. The question is, should we persevere with these iron ore majors or cut our losses if you have some and buy more reliable companies that only cop it when the overall market is crushed?

The outlook

This timely question comes as three heavyweight financial titans — Citigroup, UBS and Goldman Sachs have written off iron ore prices, declaring the end of the Iron Age.

Against this negativity, there are those who say BHP, Rio and Vale are acting like OPEC, using oversupply tactics to drive down the price to KO rivals, which in turn will either go out of business or be swallowed up by the price-manipulators.

And while this might make perfect sense to a company like Rio, where the breakeven price has fallen to $US34, while a month ago, before the dollar dived, it was $US43.

Meanwhile Goldman is tipping a $US60 a tonne for 2015, which is a big markdown from the $US80 predicted previously.

Recently BC Iron’s managing director Morgan Ball was just breaking even but he expected a spike in the iron ore price to around $US70 to coincide with the Chinese New Year. However he expects a sell-off again in the second-half of the year.

Two big issues are driving this fall in price — the oversupply strategy from the big players, while smaller players keep adding to supply for cash flow reasons and the slowdown in demand from China.

This analysis by Goldman’s Christian Lelong worries me a little with this observation: “A painful war of attrition awaits.” By that she means the iron ore industry will see the biggies try to take out the less competitive mines.

The long haul

Ultimately the big guys will win and this should be reflected in their share price but it could be a two- or three-year wait for the big pay-off. OPEC majors would have the same plan — lose now, win later!

My view is that it is believable that BHP and Rio could go up by, say, 5% over the course of the year and as the dividends are at least 4%, with franking credits they could pay you 10%. And if I’m wrong on share price by a factor of two, you still might make around 7%.

Citigroup tips the iron ore price to be $US58 and UBS says $US66, which pressures the likes of BC Iron but makes life OK for BHP and Rio. And you have to throw in lower energy costs and a lower dollar, which are two more pluses for these seriously important exporters.

And by the way, we had 59% of the Chinese market for iron ore on a high dollar so it could be even better on a lower dollar.

I’m not saying BHP and Rio are screaming buys but they’re not straight out dumpers either. If you don’t want to wait for medium-long returns, maybe you should look for more reliable companies. I like NAB, especially with the targets of $42 on the stock around nowadays, but I was recommending that one a year ago.

Last week on my Switzer TV program, FN Arena’s Rudi Filapek-Vandyck argued that BHP and Rio could languish with weak results like in the 1990s, while Professor Ron Bewley, with his sector analysis gave materials a thumbs up for 2015.

Here’s that chart:
 

Now Bewley surveys a wide group of analysts for his sector analysis and, of course, they can be wrong but it’s a consensus view. Reading his chart they’re saying they expect an 11.6% gain on share prices and 4% from dividends! (By the way, his exuberance measure is a measure of under or over-pricing.)

We all know stock picking and sector analysis is not a precise science but Bewley has a good track record, devising the system when he headed up investment research at CommSec.

I’m sticking with them

Hope that helps and I can honestly say that I’m sticking with BHP and Rio, but I do have 18 other stocks in my portfolio that are pretty reliable dividend payers and are OK in the capital gains caper too.

One last omen to report. Kerry Stokes, through his Seven Group, has been prowling through the mining sector — especially energy — and it’s the low prices that are explaining that.

As Buffett says “be greedy when others are fearful” and that’s always worth remembering when you’re buying good companies at lower prices.

Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.

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Important information: 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. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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