Flying Down to Rio

06/19/2008 12:00 am EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

Roger Conrad and Yiannis Mostrous, editors of the Vital Resource Investor, tell why Brazil’s Vale remains an attractive way to play the materials and commodities boom.

The world’s biggest iron ore mining company is Brazil’s Companhia Vale (NYSE: RIO), and it’s also hell-bent on growing much larger. The company has announced it’s looking to issue new equity to the tune of US $15 billion. That adds a great deal of credibility to continuing reports that management is getting ready to push for another big acquisition.

The company failed to snare Xstrata earlier this year. But it’s still likely to be seeking a company that can further diversify its output. [Besides being] the world’s largest iron ore producer, [it is the second] largest nickel producer. The company also has growing aluminum, copper, and coal businesses. And that’s where its targets are likely to be as it works to increase its dominance as a major producer of vital resources.

When it comes to that kind of growth, acquisitions are a far easier road for RIO to reach its goal than going further and deeper to seek out new sources. And it has the scale to [make] any deal it wants.

Two companies frequently mentioned as potential targets are Anglo American (Nasdaq: AAUK) and Freeport-McMoRan Copper & Gold (NYSE: PCX). Anglo is one of the world’s largest diversified mining companies and is a prolific producer of a wide range of resources. Its key attraction is platinum.

Freeport, meanwhile, would give RIO exposure to some of the largest copper and gold mines in the world. The Grasberg mine in Indonesia is still its most important facility. But last year’s acquisition of Phelps Dodge has dramatically diversified operations geographically. The company is also pushing up production of molybdenum, an increasingly important element for the harder varieties of steel that will be needed to plumb the oceans’ depths for energy.

We’re also not ruling out a new bid for Xstrata. Based in Switzerland, the company has operations in six copper, coking coal, thermal coal, ferrochrome and platinum, vanadium, and zinc mines.

Of course, this isn’t a complete list of candidates that would theoretically fit RIO’s profile. The difference between these three companies and others is they already have the scale to thrive on their own. That’s the key criterion for investing in any takeover target, and it’s the only way to ensure you won’t get burned should takeover fever cool.

As for RIO itself, strategically any of these potential combinations will be a big positive, turning it from an iron ore play into a legitimate, diversified miner with a global presence.

Our case for RIO has always been its commanding position in the iron ore market and our assessment that iron ore prices will remain elevated next year, too. We still believe this will be the case, and you should buy the stock in every dip. (The ADRs closed a little above $36 Wednesday—Editor).

We continue to view it as a long-term winner, whether the company does or doesn’t acquire another mining player.

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