Sector in Focus: BHP Biliton vs Rio Tinto

Both companies are well placed to generate returns for at least a decade but which of the mining jugganauts provides better investment opportunities for the future? 

Mark Taylor 10 October, 2013 | 12:30PM
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High-quality resources support above-average returns for  BHP Billiton (BHP) and  Rio Tinto (RIO) compared with the resource industry generally and the more select group of diversified global mining peers. Both companies are attractive investment propositions and are well placed to generate excess returns on average for at least a decade to come. Both BHP and Rio have large portfolios of long-lived, low-cost mines assembled throughout many decades. Operations include world-class hubs in iron ore, copper, coal, aluminium and, in BHP's case, petroleum. Many of these are effectively irreplaceable, with low sovereign risk and proximity to key Asian markets. For the replicable assets, often the capital cost is multiples of that BHP and Rio originally paid, with Pilbara iron ore a good example.

Both companies' earnings are heavily skewed to iron ore, Rio particularly so given the failed diversification with the 2007 Alcan purchase. We expect a more even distribution of product contributions for both BHP and Rio as the China-driven skew to iron ore unwinds. Improving margins and stronger earnings overall will allow Rio's dividends to grow in line with those of BHP. However, Rio will remain skewed to iron ore and overall margins and returns will continue to lag those of BHP. Both are world-class miners, with BHP the higher quality despite Rio being more attractively priced at present.

BHP was the clear winner in the last decade. BHP outclassed Rio on numerous financial metrics, producing a total 45%, or $72.2 billion, more in earnings before interest, tax, depreciation and amortisation (a measure known as EBITDA) than Rio to June 2013 from a similar starting base. It achieved this at higher average margins and returns on capital while maintaining a more balanced asset portfolio and lower average gearing. This allowed BHP to pay out twice as much in dividends, after adjusting for net share issues and differences in the starting capital base. The performance largely reflects BHP's favourable petroleum move, in contrast to Rio's woeful Alcan move which it is unlikely to repeat.

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Mark Taylor  is an equity analyst at Morningstar.

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