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Drilling for Profits - The Mining Industry Can Still Produce Winners
Posted by: Patricio Kehoe (IP Logged)
Date: September 9, 2013 04:55PM
The uncertainties surrounding the commodities market are troublesome. Mining giants such as Gold Fields (GFI) and BHP Billiton (BHP) will face different outcomes in coming years depending on their current strategy. Internal growth and product diversification may help these companies counteract declining prices.
Mining for Gold
Gold Fields has managed to recover from the drop in gold prices, through an internal growth strategy. Apart from its three mines in South Africa, the firm operates in Ghana and Australia. Additionally, the company owns the Cerro Corona mine in Peru, which boasts cash costs well below the industry average. Despite any troubles Gold Fields might be facing, the two major owners, Van Eck Associates and Arnhold & S. Bleichroeder Advisers have increased their stake in the firm by over 8 million shares each.
Stabilizing the gradually decreasing production at its traditional South African gold mines, which have been operational for decades, is becoming a challenge for Gold Fields. Declining head grades and increasingly deeper mining shafts, have turned these mines labor-intensive and rather inefficient. The relatively new gold mine South Deep, inaugurated in 2006, however, looks promising. An increase in revenue and production rates is expected, once South Deep reaches maximum capacity. Nevertheless, declining gold prices, deficient energy infrastructure in South Africa, and elevated labor costs due to a unionized workforce make further expansion difficult.
Gold Fields is financially solid and has relatively small debt. The steady increase in revenue over the past years gives credit to the firm’s internal growth strategy. Gold Fields is currently trading at 6.4 times its trailing earnings, resulting in a significant price discount to its industry median. Considering its large price discount, along with the firm's financial soundness and future prospects for growth, I feel optimistic about this stock.
Diversification Is the Key
As the world’s largest mining conglomerate, BHP Billiton supplies a large range of products including copper, coal, uranium, nickel, silver and iron ore among others. Its main strength resides in its diverse portfolio and wide customer base, which results in more balanced cash flows and lower operating risks than most of its competitors. Apparently, Ray Dalio from Bridgewater Associates is just as excited about this stock as I am, considering he increased his stake in the firm by 350%.
Offering not only commodities but also energy products has strengthened BHP Billiton's balance sheet significantly. In addition, the firm is expected to continue benefiting largely from its proximity to the Asian markets. Nevertheless, demand for commodities is declining, due to the maturing of Asian economies and global economic stagnation. In the short term, this has led the company to shift its attention to fiscal discipline and cost reduction. In the long run, however, BHP Billiton can generate profits from industrial development across different geographies. Furthermore, the firm currently has 18 projects in the pipeline, which will boost production volumes and revenue by 2015, when they come on line.
Considering the BHP Billiton’s completion of new projects in the next two years, which will boost revenue, the increase in the firm’s debt levels is not significant. Also, BHP Billiton is currently trading at 17.6 times its earnings ttm, resulting in a significant price discount to the industry median. Due to the firm's ability to overcome economic cycles, along with its financial stability, I feel optimistic about this stock.
Diversification in Times of Trouble
Although the commodities market has taken a toll due to the decline in Chinese growth rates and global economic stagnation, future shareholders have good options when investing in the mining industry. BHP Billiton's large portfolio and wide customer base generate stable cash flows and a low operating risk, giving it an edge over Gold Fields.
[b][/b] Disclosure: Patricio Kehoe holds no position in any stocks mentioned
Stocks Discussed: GFI, BHP,
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