BHP and Rio’s diverging paths

One’s diversifying, the other’s increasing its exposure to a commodity who’s price is likely to fall

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Our two biggest mining companies may appear similar, but the differences are likely to be very noticeable in the next few years.

BHP Billiton’s (ASX: BHP) chairman Jac Nasser has told shareholders at yesterday’s annual general meeting that he doesn’t expect any significant rise in iron ore prices soon.

The iron ore price is currently around US$120 a tonne, after hitting as low as US$90 a tonne in September. At the current prices, iron ore miners like Fortescue Metals Group (ASX: FMG) and Mount Gibson Iron Limited (ASX: MGX) may still be able to make a profit, but demand from China is expected to moderate and as additional supply comes online, iron ore prices are likely to fall. That could have an devastating impact on the small to medium miners with higher production costs.

Related: Looking into the future of mining

Mr Nasser said that China is not expected to grow at the same pace it has in the past – a view shared by Rio Tinto Limited’s (ASX: RIO) chief Tom Albanese. Mr Albanese expects China to grow at around 8%, above the current year’s 7.5%, but below the double-digit growth experienced in the past decade.

At the same time, Rio has announced plans to cut its operating costs by more than US$5 billion by the end of 2014, mainly in its coal and aluminium divisions, including further job cuts. Mr Albanese also flagged that operations will be closed, if they don’t deliver the cash flow.

Diverging strategies

Both miners have adopted a cautious approach, cutting costs and preserving capital, although their paths are diverging significantly. Rio has expanded its iron ore operations, and is also focused on coal, copper and aluminium. BHP on the other hand, has expanded heavily into oil and gas, pushing into new commodities like potash, and exiting non-core businesses like diamonds and uranium.

Rio’s strategy looks the riskier, being heavily dependent on iron ore. The commodity represents around 80% of its revenues currently, and is increasing as Rio expands its production to 353 million tonnes a year by 2015. That puts the company at significant risk of falling iron ore prices.

The Foolish bottom line

While Rio does have some diversification, its increasing reliance on iron ore makes it a riskier stock. The company also has the aluminium albatross around its neck. Rio has already written off US$17.3 billion from its US$38.1 billion purchase of Alcan in 2007, but further writedowns could come. For Foolish investors looking for a solid, diversified resources company, the best option might be the Big Australian, BHP.

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Motley Fool writer/analyst Mike King owns shares in BHP. The Motley Fool’s purpose is to help the world invest, better. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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