Mining Value Stocks: Beginning to Dig Out?

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JOY
Joy Global

Submitted by George Putnam, III as part of our contributors program.

Mining Value Stocks: Beginning to Dig Out?

I was at best early–and perhaps wrong– when I highlighted the mining sector two years ago. The good news is that I recommended sticking to the large, well-capitalized companies in the sector. As a result, while the stocks we highlighted then have not performed well in the interim, they have not been crushed like many of the more leveraged names in the sector, some of which are down 80% or more.

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What I did not anticipate two years ago was the rapid decline in Chinese demand for coal and other commodities and metals. This pushed the prices for many commodities down sharply, and the profits and stock prices of the commodity producers followed.

I do not claim to have any expertise in forecasting Chinese demand. What I am seeing, however, are the beginnings of supply reductions in a number of metals. Mines and smelters are being closed to reduce the higher cost production, and there are rumblings of possible mergers among some of the players that could lead to further cutbacks. If commodity supplies are brought into line with the reduced demand, prices will stabilize and the stocks will begin to move up. Should Chinese demand pick up again, the supply cutbacks could cause commodity prices–and the related stocks–to rebound very sharply.

Because my crystal ball on all of this is still pretty hazy, I am once again suggesting that you focus on the larger players with the stronger balance sheets. Many of the smaller, more leveraged miners and metals producers may not survive if commodity prices stay low for a prolonged period.

Freeport-McMoRan is the world’s largest publicly traded producer of copper, which accounted for 60% of 2014 revenues. Oil & gas represent 20% of sales, and gold and molybdenum round out Freeport’s revenue base. Management has recently been focused on improving the balance sheet–they sold $5 billion in assets in 2014 and are considering additional divestitures. I was too early in the commodity cycle with our August 2013 recommendation, but I still like the company’s long-term prospects.

Rio Tinto is a well-regarded, world-wide miner that produces a diverse range of mineral resources. Unfortunately, it made the mining industry’s largest acquisition ($38.1 billion) right at the peak of the commodity cycle in 2007. That CEO is gone, however, and Rio’s operations and finances look solid. Rio has weathered many commodity cycles over its 140-year history, and it is likely to rebound strongly when this one eventually turns.

Another way to play a possible rebound in mining would be through the stock of Joy Global, which produces mining equipment for both surface and underground mineral extraction. Revenues are down more than 30% from their peak in 2012, but the company is still solidly profitable, and the balance sheet is decent. Joy is cutting costs, which will boost the bottom line when mining recovers.