While the price of iron ore has fallen to a ten-year low in recent months, the share price of Rio Tinto Limited (ASX: RIO) is down by just 3% in the last year. Certainly, it has been down by as much as 10% during the period, but when you consider how astronomical the fall in the iron ore price has been (and the fact that Rio Tinto depends on the steel-making ingredient for around 90% of its profit), it's a wonder that the company's share price isn't much lower.
In fact, sector peer, BHP Billiton Limited (ASX: BHP), is down 24% in the last twelve months. That's a disappointing performance – especially when you consider that BHP is a much more diversified business than Rio Tinto, although it did recently spin off its South32 assets.
Past performance
Furthermore, BHP's bottom line was hit far less hard by the general fall in commodity prices than Rio Tinto's. For example, in financial year 2014, BHP reported a 12.2% rise in its bottom line, with cash flow per share rising by a whopping 36.8%. Rio Tinto, meanwhile, saw its net profit decline by 19.4%, with cash flow up just 3.3%, and yet its shares have outperformed those of its peer throughout the last year.
Anticipation
Of course, the stock market tends to think ahead rather than look backwards. And, with Rio Tinto expected to return to profit growth in FY 2016, investors appear to be taking this into account. Certainly, Rio Tinto is expected to grow its earnings at a rate that is only slightly higher than the wider index; 9.3%, but it compares favourably to the continued fall in earnings that is expected at BHP next year.
Valuation
Despite the improved outlook for Rio Tinto, its shares trade at a significant discount to those of BHP. For example, Rio Tinto has a price to earnings (P/E) ratio of just 11.3 (versus 15 for BHP) and also has a price to book (P/B) ratio of 1.87 (versus 1.96 for BHP). As such, Rio Tinto appears to offer a brighter medium term outlook at a lower price than BHP.
Strategy
Of course, the two companies have strategies that are somewhat similar. They are both seeking to increase production so as to strengthen their position on a relative basis. Clearly, both Rio Tinto and BHP are two of the most financially sound companies in the mining sector, but many of their peers are struggling to generate a profit due to their higher cost curves. Therefore, it makes sense for Rio Tinto and BHP to put the squeeze on their rivals as they attempt to increase their market share for the long term.
Income Prospects
While the two stocks both yield around 5%, Rio Tinto's dividends are set to be covered 1.2 times this year, while BHP's are due to be covered 1.1 times. And, with Rio Tinto's earnings forecast to rise, and BHP's to fall, the former seems to offer a more sustainable dividend for the medium term. Clearly, dividends will largely depend upon the price of iron ore, but all other things equal, Rio Tinto looks to be the safer income play of the two companies.
Looking Ahead
So, with better growth prospects, a lower valuation, stronger investor sentiment and a more sustainable dividend, Rio Tinto appears to be a better buy than BHP. Clearly, BHP remains an appealing stock, with it having greater diversity, the potential to drive through efficiencies after the South32 spin-off, and a sound strategy. However, if you can only buy one of the two, Rio Tinto seems to be the top pick.
