Go to Rio and BHP for value in a portfolio

AS with the lore that the IT guy never gets sacked for buying IBM, few brokers would shy from suggesting BHP Billiton -- the world's biggest miner -- as a core part of any conservative portfolio. But does rival (and occasional ally) Rio Tinto offer better value?

Once the undisputed king of the heap, Rio Tinto has had to settle for second best since (over) paying $US40 billion for aluminium producer Alcan at the height of the bull market. But Rio still remains the world's third-biggest digger, behind Brazil's Vale.

Rio shares have outperformed BHP shares since Rio's decision last year to jettison its unpopular $US19.5bn Chinalco deal in favour of a monster capital raising. But Rio shares still trade on a more modest price-earning multiple (about 14 times expected current-year earnings falling to 12 times in 2010-11) than BHP (17 times, falling to 13-14 times).

Superficially, Rio represents better value but the investment decision hinges on what commodities offer the most excitement. Rio is bigger in iron ore and both are big in copper, but Rio post Alcan is enormous in aluminium while BHP offers oil and gas exposure, which Rio simply doesn't have.

Start of sidebar. Skip to end of sidebar.

End of sidebar. Return to start of sidebar.

Also, Rio has no nickel while BHP has plenty (but probably wants less after the Ravensthorpe debacle).

On research house Morningstar's analysis, despite Rio's laggard reputation it outperformed BHP on cashflow measurements through the past eight years. BHP outperformed on earnings per share, but only marginally, and has consistently increased its dividend while Rio's has faltered.

Arguably, BHP has more attractive growth projects: in a recent report, Deutsche Bank lists BHP's next wave of six growth projects, requiring a collective investment of $US8bn ($8.7bn).

They are the Macedon (WA domestic gas), Guinea (alumina), Navajo (Mexican thermal coal), the Yeelirrie uranium deposit in WA, Queensland coking coal expansion and an extension of the Escondida copper mine in Chile (7.5 per cent BHP-owned).

Deutsche values the worth of the projects at $1.82 a share, but is only willing to ascribe a present value of 55c a share. “The uplift in value is relatively modest, given the significant capital investment,” it says. “However this is indicative of the challenge that faces BHP (and to a certain extent all the large diversified mining companies) in that many of the easy brownfield opportunities have now been exploited.”

Rio talked up the potential of its Simandou iron-ore project when it was fending off BHP's hostile advances. Last month, however, Rio sold 44 per cent of the project -- considered the richest undeveloped iron-ore deposit -- to reconciled chum Chinalco for a $US1.35bn share of the development cost (which in big miners' terms is coins down the back of the couch).

That's not to say Rio is devoid of projects, although the Alcan debt has constrained its balance sheet. This year Rio plans to spend $US5-6bn compared with BHP's $US11.5bn.

Rio's growth irons include the Diavik diamond mine in Canada, Mongolian Oyu Tolgoi copper-gold project, Escondida (it owns 30 per cent) and expanding Pilbara iron-ore output from an annual 22 million tonnes to 330 million tonnes.

The interests of both BHP and Rio investors -- and there's a high degree of common shareholdings -- will be served by the planned union of the miners' Pilbara operations. But given the local and offshore regulatory obstacles, the claimed $US10bn of synergies look illusory.

While it's impossible to glean what commodity will perform best, Criterion would opt for BHP's more balanced portfolio over Rio's aluminium-centric one (it added up to27 per cent of Rio's sales last year). But the aluminium recovery has lagged that of copper, zinc and lead and is due for catch-up. On balance, can we take the IBM approach and suggest both?