Why I Would Buy Rio Tinto plc Ahead Of BHP Billiton plc Today

Rio Tinto plc (LON: RIO) has its troubles but it still looks a more tempting pic than BHP Billiton plc (LON: BLT), says Harvey Jones

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It has been a rough year for FTSE 100-listed mining giants BHP Billiton (LSE: BLT) and Rio Tinto (LSE: RIO), which have fallen 33% and 25% respectively in the past 12 months. As China — their main customer — continues to struggle, it would take a brave investor to buy either company right now. But fortune favours the brave, and at today’s cut-price valuations both stocks also have plenty to offer rock-hard investors.

Dividend Fears

The most obvious temptation are the mineral-rich income streams, with BLT and RIO currently yielding an astonishing 7.83% and 5.83% respectively. These were traditionally considered growth stocks rather than income machines, but recent travails have reversed that. However, BHP Billiton’s yield has edged into the “too good to be true” category and analysts are now questioning its sustainability.

In fact, SocGen has just downgraded BHP Billiton to ‘hold’ from ‘buy’ because of the pressure its generous dividends are placing on the balance sheet. Management is still hanging tough, recently hiking the full-year dividend by 2.5% to 124 cents, despite a drop of around 50% both in operating profits and underlying earnings per share. It has partly funded this through an impressive $4.1bn cost-cutting programme, but you can only cut so much until future growth prospects are put at risk.

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Rio’s Brio

Rio’s yield may be lower but management policy has been even more progressive, hiking the 2015 interim dividend 12% to 107.5 cents. SocGen reckons that Rio’s stronger balance sheet points to a more sustainable yield, and has upgraded the miner from hold to buy. Confirming this, Digital Look puts BLT’s dividend cover at just 1 times, against 2.3 times for Rio Tinto.

I have always been wary of Rio because it is so heavily exposed to one mineral in particular, iron ore, which makes up about 90% of its production. But this has worked in its favour as the iron ore price has stabilised in recent months. Although it is down from around $80 per metric tonne to around $56 over the last year, the price avoided crashing through $50 as anticipated, and has even crept up over the last six months. Other metals have had a tougher time either side of China’s Black Monday, for example copper is down nearly 20% since May from $2.90 a pound to around $2.35 today.

RIO Versus BLT

A quick look at the numbers shows Rio Tinto repeatedly outscoring BHP Billiton. Its operating margins are 23.8%, against BLTs 18.2%. Return on capital employed (ROCE) is 11.3% against 7.9%. Despite this, Rio Tinto is notably cheaper, trading at 6.8 times earnings against a surprisingly high valuation of 13.1 times at BHP Billiton.

In the wake of the death of the commodity super cycle, investors should approach both stocks with caution. One dismal number is common to both: BHP Billiton’s earnings per share are expected to fall by 53% in the year to 30 June 2016, while Rio Tinto’s are forecast to drop 49% this calendar year. Next year, Rio’s EPS are forecast to fall just 3%, suggesting the worst may be over. We’ll see. Both stocks face trouble ahead, but BHP Billiton’s path looks bumpier.

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Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Harvey Jones has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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