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Down heavily in 2015: What’s next for Fortescue Metals Group Limited and Rio Tinto Limited?

The rout in the share prices of major mining companies seems unstoppable as commodity prices continue their downward slide.

Although mining as a sector is dependent heavily on capital expenditure to run and manage new and existing mines. Sometimes, global and macro-economic conditions create opportunities to invest in mining companies at prices which are unbelievably low and make good business sense.

Market forces have created a once-in-a-decade window of opportunity in the mining sector. Which is too good to ignore as several quality mining companies are looking unbelievably cheap, and thus too good to pass on as an investment opportunity.

Two such quality mining companies are Rio Tinto Limited (ASX: RIO) and Fortescue Metals Group Limited (ASX: FMG).

Rio Tinto Limited (ASX: RIO) – Rio Tinto’s largest business is seaborne shipment of iron ore from the Pilbara region. Despite the drastic falls in worldwide prices of iron ore, Rio Tinto has a massive cost advantage in production of iron ore. Rio Tinto’s current cash unit cost for iron ore production is US$16.20 per tonne and it has an industry leading Earnings Before Interest Tax Depreciation and Amortisation (EBITDA) margin of 61% from the iron ore business.

Rio Tinto’s second-largest business is the mining and production of Aluminium in which it is recognised as an industry leader. While the iron ore price is dropping, the price for Aluminium rose 2% in 2015. Demand for aluminium is forecast to rise significantly in the future as more cars will be manufactured with light weight aluminium to reduce toxic emissions.

Fortescue Metals Group Limited (ASX: FMG) – Fortescue Metals only produces iron ore from the Pilbara region and is the world’s fourth-largest iron ore producer. Despite the falling iron ore prices Fortescue Metals shipped 33% more iron ore during the financial year ending June 30, 2015.

Fortescue has been taking steps to reduce costs as the falling iron price puts pressure on the industry. For the 2015 financial year the operating costs of mining, processing, rail, and port for the iron ore were US$27 per tonne, a 21% reduction from last year. For the 2016 financial year, Fortescue Metals is targeting a further reduction in cost, and is aiming for US$18 per tonne.

The key risk with Fortescue Metals (apart from falling iron ore prices) is the high net debt of US$7.2 billion as at 30 June, 2015.

  P/E ratio P/B ratio Operating  Margin Key Strengths
Rio Tinto Limited (ASX: RIO) 12.41 1.41 38.40% Low cost iron ore producer.

Industry leadership in Aluminium.

Fortescue Metals Group Limited (ASX: FMG) 8.70 0.57 28.60% World’s fourth largest iron ore producer.

Source: Commsec

Foolish takeaway

Both Rio Tinto and Fortescue Metals share prices are selling at historical lows, not seen in almost a decade. Rio Tinto’s diversification and leadership in the aluminium business makes it an outstanding company worth investing in at the current share price. Fortescue’s high debt and exposure to only iron ore makes it more risky and speculative.

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Motley Fool contributor Qaiser Malik has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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