Hard Commodities - BHP Billiton Versus Rio Tinto
Concentration Versus Diversification
The main difference between BHP Billiton and Rio Tinto is their different revenue sources. While Rio Tinto is very much concentrated in iron ore - since its one of the most efficient producers of the mineral in the world - BHP Billiton is much more diversified across different commodities. BHP Billiton gets “just” 40% of its EBITDA from iron ore, around 35% from oil and 17% from its copper business.
Of course, diversification comes at a price. While BHP trades at 2014 12 times earnings and 6.2 times EV/EBITDA , Rio Tinto sells for 2014 10.3 times earnings and 6 times EV/EBITDA. If we brake up BHP's valuation into its main pieces (oil and mining) we find some interesting insights. The Australian company's petroleum segment sells for 10.6 times earnings and EV/EBITDA of 5.2 times, very close to similar oil peers. Meanwhile, BHP's mining segment trades at 15 times earnings and EV/EBITDA of 9.8 times, well above its “mining only” peers.
Both companies have their pros and cons. BHP has extremely interesting shale operations in the US and significant potash, iron ore and copper projects ahead. Besides, the company should be able to finance a great deal of its declining Capex through the sale of non-core assets such as the less economic parts of its shale acreage – specially the Southern block of its Permian acreage. On the other hand, Rio Tinto is committed to increase its dividends and buybacks aggressively in 2015 as the company's debt gets pay down by the end of 2014. I would expect Rio Tinto's net debt to go down to $15 billion (0.75 times 2014 EBITDA) by the end of 2014 from today's $22 billion (1.1 times 2014 EBITDA).
Choosing the Right Alternative
BHP Billiton and Rio Tinto, both held by Ray Dalio, are wonderful companies in many aspects if you decide to get exposure to hard commodities. In BHP's case you are buying a more diversified company with longer term projects selling at a premium, which I believe its not worth paying. The reason is simple: You can always diversify your portfolio across industries through buying multiple “single industry” companies. History has clearly shown that, in average, more concentrated companies perform better. Besides, “single industry” companies are always better M&A targets than companies that are more diversified across sectors.
On top of what I mentioned before, if we focus on Free Cash Flow (FCF) yield, which is now becoming a preferred measure of value within the commodities sector, Rio Tinto also looks cheaper than BHP. Rio Tinto is expected to generate a 10% FCF yield in 2014 and a 16% FCF yield in 2015. Meanwhile, BHP is expected to generate a 7% FCF yield in 2014 and a 9% FCF yield in 2015.
Under most measures Rio Tinto looks like a more compelling investment than BHP, even when BHP's management is now targeting to lower its spend by 25%. Hence, go long Rio Tinto if you are thinking of getting exposed to hard commodities!