Mining's Glittering Future

A booming market for commodities, and undervalued shares, are two reasons high-fliers BHP Billiton and Rio Tinto made it into the BW 50

For investors looking to ride the growth of emerging economies, no sector has produced more spectacular results than once-sleepy mining and minerals. Boosted by soaring demand from China, India, and other fast-growing countries, commodities producers have racked up huge revenue and profit gains even as other companies have faltered in the wake of the credit crunch and slowing Western economies.

Topping the list of high-fliers are Rio Tinto (RTP), which ranks No. 7 on this year's European BusinessWeek 50, and its rival and would-be suitor, BHP Billiton (BHP), which ranks No. 24. Both have benefited mightily from a boom that has seen the price of base metals and minerals double or triple in the past 18 months. Shareholders have benefited as well: Rio Tinto shares are up 84% in the past 12 months, while BHP Billiton's are up 54%.

The surge of cash into both companies' coffers has allowed them to open new mines and acquire rivals. And last November it prompted the most audacious consolidation play of all: BHP proposed to acquire Rio Tinto for an eye-popping $142 billion in stock, which offer Rio swiftly rejected (, 11/9/07). Two months later, China's largest aluminum maker, Chinalco, and Pittsburgh-based Alcoa (AA) raised the ante by plunking down $14 billion for a 12% stake in Rio (, 2/01/08). The value of BHP's offer has now risen to $160 billion, but Rio continues to resist it.

Commodities Bubble?

Despite such gigantic valuations—and the drama of a drawn-out takeover bid—analysts see still more potential. Charles Cooper, mining analyst at London's Evolution Securities, figures both BHP and Rio have strong growth prospects, particularly in their core iron ore businesses. Iron prices are expected to increase an additional 40% to 60% this year alone, and BHP and Rio together control almost 40% of the world's production.

There's also room for their share prices to appreciate. Jeremy Gray, mining analyst at Credit Suisse (CS), reminded investors in a recent research note that the cost of lead—up 200% since January, 2007—has risen at twice the rate of BHP's share price over the same period. "Mining equities have underperformed…and a catch-up appears imminent," Gray says.

To be sure, some observers worry about a commodities bubble. If Western financial volatility and economic weakness spread to emerging economies, demand for raw materials could slacken just as BHP and Rio bring new mines online. Thanks to such increases in capacity, the supply of raw materials inevitably will catch up with demand at some point. But one surprising factor that could keep prices high well into 2010 is a global shortage of equipment, transportation capacity, and qualified engineers to oversee new projects.

Fighting Over Their Companies' Futures

The protracted mating dance between BHP Billiton and Rio Tinto also could be a distraction to management. Rio continues to spurn the offer, but market-watchers expect BHP may sweeten the deal with a cash component. Complicating matters is the fact that the hostile bid has led to public animosity between Rio CEO Tom Albanese and his BHP counterpart, Marius Kloppers.

With so much at stake, it's no wonder Albanese and Kloppers have turned the fight over their companies' futures into a personal competition. Buoyed by strong demand from emerging markets, BHP Billiton and Rio Tinto are at the forefront of the mining sector's 21st century gold rush. And that has earned them, once again, a place in the European BW 50.

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