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Why I’m not buying the big miners

Credit: iStock

I’m not a buyer of any of the big miners like Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP) today. I’m even steering clear of some of the smaller miners like Fortescue Metals Group Limited (ASX: FMG) and Whitehaven Coal Ltd (ASX: WHC). Why?

Well it all has to do with two things – China, and pricing:

China

China has had a once-in-a-lifetime growth spurt over the past 20-30 years and it has led to a huge explosion in demand for iron ore (for use in steel) and coal (for use in steel and in power plants). It also led to the country and its banks taking on titanic amounts of debt, and many Chinese factories and most of its debt are not employed productively.

That is, many Chinese factories and debts (such as those used for funding construction) barely earn enough to justify their existence, let alone contributing to the economy. A Bloomberg 2016 report found that the Chinese Energy and Materials sector has about a 1% return on equity and a 1% return on assets.

The Chinese government is looking to cut back on its steel and coal production in order to improve the overall profitability of these industries. Some have seen this as bullish for coal, however that overlooks the rampant pollution problem in China, and the company’s determination to move towards cleaner energy sources. It also doesn’t seem likely that lower steel production would be good for iron ore demand.

Pricing

None of our mining companies is really a standout from a valuation perspective. Whitehaven, Rio, BHP, and Fortescue are all basically flat over the last 10 years, with their share prices having recovered from the slump last year. While they could still be cheap if commodity prices stay strong or improve, to my mind there is little margin of safety given the problems I just talked about in China.

China is the world’s largest buyer of iron ore and coal by some 6x-8x its nearest competitor (iron ore) and 1.5x for coal. With that in mind I think it’s important to remain cautious and aim to buy miners at a price that is very obviously undemanding – which they do not appear to be at the moment.

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Motley Fool contributor Sean O'Neill has no position in any of the stocks mentioned. 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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