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3 Mining Stocks That Went From Debt Hogs to Cash Cows

By Igor Greenwald on September 21, 2017

These are the best of times for mining stock investors. Commodity prices have bounced back, for real this time.

Much of the rebound for mining stocks has a lot to do with the fact that the big price picture looks like this:

We’re less than two years removed from a huge five-year commodity bust that buried the China growth story and the never-very-bright embers of broader economic optimism in the wake of the Great Recession.

So miners have clearly seen better days. Their equity, on the other hand, is promising prospecting terrain right now for those seeking capital gains with a great income kicker.

Consider where the industry is now versus, say, 2010. Back then, the iron ore and copper miners were spending cash like it was going out of style on expansion projects meant to satisfy Chinese demand that was, in fact, close to peaking. Investors who joined the “buy anything you can drop on your foot” party late have never walked right since. 

Today, prices as well as expectations are much more modest, even as Chinese growth surprises to the upside. Miners have been chastened as well, and now claim to prefer returning money to shareholders to digging new mines.

They’ve cut operating  costs steeply during the lean years, and low energy prices have further aided that cause. Meanwhile, metal prices have improved. While certainly nowhere near the 2011 peak, they’ve moved decisively off the 2015 lows.

Here’s iron ore:





Higher realized prices have done wonders for miners’ free cash flow. And given their newfound religion on curbing supply, the price gains should stick. Let’s take a look at three solid bets now:

Rio Tinto (NYSE: RIO) is one of the world’s largest miners, with iron ore accounting for 62% of its recent core cash profit. The rest came from aluminum, energy, copper and diamonds.

The trailing yield on its variable distributions is currently 4.9%.

Rio’s preferred profit measure was up 68% in the first half of 2017 year-over-year. From its $6.3 billion in first-half operating cash flow, capital spending consumed $1.8 billion, leaving $2 billion for dividends and $1 billion allocated to a share buyback. Net debt was reduced by $2 billion during the first half of the year.

The company is selling Australian coal operations and promising to generate an additional $5 billion in cash flow from productivity improvements over the next four years. Capital spending is expected to increase 10% next year and remain level in 2019.

BHP Billiton (NYSE: BBL) is the other giant worth considering. Its profit mix is currently 44% iron ore, 20% oil and gas, 19% coal and 17% copper.

The stock has a trailing dividend yield of nearly 4%.

Capital spending has been dramatically downscaled since the boom years, leaving the company with $12.6 billion of free cash flow for the year ended in June; annual dividends will cost $4.4 billion.

BHP has postponed a potash mining project and is reportedly looking to unload it. It’s also shopping its land-based energy interests in the U.S. Debt has been paid down by $10 billion over the last year.

Alumina Limited (OTC: AWCMY) presents a more focused bet on bauxite and alumina. These are respectively the raw material and intermediate-stage precursors of aluminum. Global aluminum consumption has been growing 4%-5% annually for more than a decade. The lightweight metal and its alloys are the primary materials in airplanes and have increasingly supplanted steel in autos.

Australia-based Alumina’s entire cash flow comes from its 40% stake in a joint venture with Alcoa (NYSE: AA) that operates bauxite mines, alumina refineries and aluminum smelters around the world. The joint venture has been a capital hog for years but is now morphing into a cash cow as the partners begin earning returns on past investments.

Alumina is designed to be a pass-through vehicle funneling the joint venture’s payouts to shareholders via dividends. Payouts over the last 12 months work out to a trailing yield of 4.2%, with excellent prospects for more next year.

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