Which UK Miner Is the Best Buy?

10/12/2012 10:30 am EST

Focus: MARKETS

A number of big mining concerns trade on the London market, but only one meets the test for Roland Head of The Motley Fool UK.

Trying to predict the future is a mug's game, but despite this, I'm pretty certain that the global economy will still need large amounts of iron ore and copper in several decades' time.

That's one of the reasons why I recently added shares in Rio Tinto (RIO) to my retirement portfolio. This is a company I tipped back in June as a great buying opportunity, and which currently offers a dividend yield of 3%—below the FTSE-100 average, but quite respectable for a miner.

Income Focus
As I've written before, the investment philosophy behind my retirement portfolio is based on balanced, long-term investment in the main sectors of the global economy. Barring a global economic meltdown, I hope that this approach will provide a decent dividend income for me when I eventually retire.

Of course, Rio isn't the only big miner in the FTSE-100. The most obvious alternative is BHP Billiton (BHP), another Australian-based diversified miner with a £40 billion-plus market capitalization and a big business in iron ore.

I don't pretend to have the expertise necessary to independently value each of these businesses and forecast their earnings, but I do know what I want and I chose Rio for three main reasons:

  • It's cheaper. Rio currently trades on a price-to-earnings ratio of 6, compared to 9.6 for BHP Billiton. Over the long term, I expect this discount to even out.
  • Copper: Rio is in the final stages of opening a large new copper mine in Mongolia. This is expected to contribute to a 13% annual rise in earnings from the red metal between now and 2015. I see copper as a good diversifier to help reduce Rio's dependence on iron ore, from which it currently gets around 80% of its earnings.
  • 23% of BHP's earnings came from its petroleum business in 2012. As I already own shares in Royal Dutch Shell (RDS.A), I didn't want any more oil exposure.

An Alternative Idea
Given my goal of gaining an income stream from the global commodities market, I did identify another attractive possibility that you might want to consider.

If it succeeds, the proposed merger between Xstrata (London: XTA) and Glencore International (London: GLEN) will create the biggest mining and commodities company in the FTSE 100. 'Glenstrata' would have a market value of £53 billion ($85.1 billion), and could be an attractive long-term investment, as both companies are currently valued quite modestly.

Although mergers are always a risk, Glencore already owns 20% of Xstrata, and the two companies look like they should be a good fit. The uncertainty over the deal has driven down the share prices of both companies over the last month, and Glencore's shares are down by more than 8%—so now could be a good time to buy, as the price could rebound once the uncertainty abates.

Not My Choice
The FTSE's mining sector is home to five companies with market values greater than £20 billion. Of these, the only one I haven't mentioned so far is Anglo American (London: AAL), whose share price has dropped by more than 23% so far this year, making it by far the worst performer of the five.

Many of Anglo's operations are in South Africa, and this is causing problems at the moment. Anglo American Platinum sacked 12,000 miners (20% of the workforce) at its Rustenburg platinum mine on Friday, following their refusal to return to work after an illegal strike or attend disciplinary hearings.

The company's Kumba iron ore mine is also being affected by strike action and falling commodity prices have hit Anglo hard this year. However, you could argue that much of the bad news has already been factored into the company's share price, making it a possible contrarian buy.

Read more from The Motley Fool UK here...

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