Although BHP (ASX: BHP) and Rio Tinto (ASX: RIO) are often seen as totally captive to fluctuating commodity prices, this is only true to a certain extent.
There are numerous strategies the companies can pursue, including reductions in capital expenditure, selling or closing down low yielding assets, increasing volumes, deferring projects, targeting production from higher yielding reserves and general cost cutting drives. Both BHP and RIO have been adept at this in the past, and both companies have been at it again over the past couple of years.
BHP's resource exposure is diverse – iron ore, copper, coal, petroleum, US shale and potash. The last two are still in their infancy and the move into potash is particularly interesting. With arable land declining in all continents, BHP seems to have identified the agricultural sector as having substantial long term growth potential. Potash (potassium) is one of the most common elements in the earth's crust and a particular potash bearing rock called sylvinite is the one most suitable for mining. Potash is essential for the healthy growth of many plants and is also available in bananas.
BHP is currently selling at about 11 times expected 2014 earnings and a 4% fully franked yield.
With interests in iron ore, coal, aluminium and copper, Rio Tinto's resource exposure also seems diverse. Other assets, such as the Argyle diamond mine, may be sold at an appropriate time. However, Rio has significantly more exposure to iron ore than BHP and iron ore prices are predicted to drift lower over the next couple of years.
To counter this, Rio is ramping up production with recent volumes exceeding previous records. Together with cost cutting measures and a lower dollar, this should ensure returns and margins are at least maintained. Rio is currently selling at 9 times expected 2014 earnings and a fully franked yield of 3%.
Foolish takeaway
BHP and Rio are premier resource companies locked into global economic trends, and both companies can be expected to show earnings growth from 2014. Both are low-cost producers and operate technologically advanced mines. At current price levels, BHP is trading at a 25% discount to net asset value and Rio 30%. Both are presently attractively priced on a medium term view; however I prefer the diversity of earnings and long-term potential of BHP.
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Motley Fool contributor Peter Andersen doesn't own shares in the companies mentioned.
