BHP and Rio’s diverging paths

BHP and Rio's diverging paths

One's diversifying, the other's increasing its exposure to a commodity who's price is likely to fall

Mike King

Mike King is a Fool.com.au Investment Analyst and Writer. He caught the investing bug more than a decade ago, at a time when the U.S. had invaded Iraq and fear reigned in the markets. His initial success as the markets took off encouraged his passion and thirst for knowledge. With 13 years behind him at one of Australia's largest domestic banks, Mike's passion for stocks led him to join a boutique funds management firm, where he stayed for four years. A seven-year stint in equity research at one of the largest investment banks in the world followed that, giving Mike a thirst to pursue his passion further. Mike holds a Diploma in Applied Finance and Investment and a Graduate Certificate in Financial Planning. His passion is to help retail investors invest better, and that passion was one of his primary reasons for joining The Motley Fool Australia in late 2011. Mike has written thousands of articles since joining, including for Fairfax Media, Yahoo!7, Ninemsn and has also appeared on ABC's The Business. You can see all of Mikes' holdings here

Published November 30, 2012 12:31 pm AEDT

Our two biggest mining companies may appear similar, but the differences are likely to be very noticeable in the next few years.

BHP Billiton's (ASX: BHP) chairman Jac Nasser has told shareholders at yesterday's annual general meeting that he doesn't expect any significant rise in iron ore prices soon.

The iron ore price is currently around US$120 a tonne, after hitting as low as US$90 a tonne in September. At the current prices, iron ore miners like Fortescue Metals Group (ASX: FMG) and Mount Gibson Iron Limited (ASX: MGX) may still be able to make a profit, but demand from China is expected to moderate and as additional supply comes online, iron ore prices are likely to fall. That could have an devastating impact on the small to medium miners with higher production costs.

Mr Nasser said that China is not expected to grow at the same pace it has in the past – a view shared by Rio Tinto Limited's (ASX: RIO) chief Tom Albanese. Mr Albanese expects China to grow at around 8%, above the current year's 7.5%, but below the double-digit growth experienced in the past decade.

At the same time, Rio has announced plans to cut its operating costs by more than US$5 billion by the end of 2014, mainly in its coal and aluminium divisions, including further job cuts. Mr Albanese also flagged that operations will be closed, if they don't deliver the cash flow.

Diverging strategies

Both miners have adopted a cautious approach, cutting costs and preserving capital, although their paths are diverging significantly. Rio has expanded its iron ore operations, and is also focused on coal, copper and aluminium. BHP on the other hand, has expanded heavily into oil and gas, pushing into new commodities like potash, and exiting non-core businesses like diamonds and uranium.

Rio's strategy looks the riskier, being heavily dependent on iron ore. The commodity represents around 80% of its revenues currently, and is increasing as Rio expands its production to 353 million tonnes a year by 2015. That puts the company at significant risk of falling iron ore prices.

The Foolish bottom line

While Rio does have some diversification, its increasing reliance on iron ore makes it a riskier stock. The company also has the aluminium albatross around its neck. Rio has already written off US$17.3 billion from its US$38.1 billion purchase of Alcan in 2007, but further writedowns could come. For Foolish investors looking for a solid, diversified resources company, the best option might be the Big Australian, BHP.

Oil, copper, and gold continue to be in high-demand — and their popularity doesn't look to be slowing. We've uncovered three companies poised to benefit from the rising prices of these commodities. Get our brand-new report — "3 High-Risk/High-Reward Resources Stocks" — FREE!

More reading

Motley Fool writer/analyst Mike King owns shares in BHP. The Motley Fool's purpose is to help the world invest, better. Take Stock is The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it's still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

Automatic Renewal

By taking up this offer, you will also be enrolled in our auto-renewal program, which is our way of making your ongoing subscription easier by ensuring uninterrupted service. Don't worry, though – you're not locked in, and can cancel your auto-renewal at any time before each 'anniversary' date without question or penalty.