Investor sentiment toward mining companies has soured considerably over the past few years, as growing production and slowing demand in China and other emerging markets have weighed on commodity prices.
With many pundits sounding the death knell for the commodities super-cycle, mining stocks have underperformed dramatically.
For example, the Bloomberg World Mining Index, a capitalization-weighted basket of 108 of leading mining stocks, has given up 43.7 percent of its value over the past three years. Over the same period, the S&P 500 generated a total return of 41.7 percent.
However, history should give investors hope.
Over the past two decades, mining stocks have delivered solid returns on two occasions when commodity prices declined.
The trick: Lower capital expenditures and debt levels that enabled the industry’s best-positioned players to expand their price-to-earnings multiples. Meanwhile, measured volume increases ensured that earnings didn’t collapse with commodity prices.
Mining companies have returned to this playbook during the most recent swoon, cutting capital expenditures aggressively, slashing costs, paying down debt and avoiding expensive mergers and acquisitions.
The global, diversified mining companies have reduced their capital expenditures by about US$20 billion, leading the way to curtailing some of the excess that occurred when the industry pursued production growth for growth’s sake.
With mining stocks no longer viewed as growth investments, valuations and dividend yields should become more important to investors’ decision-making process.
At the same times, earnings eventually will start to surprise to the upside, thanks to a low bar of expectations.
This turnaround won’t happen overnight. China’s economic growth has slowed, while many capacity expansions and new mining projects approved during the salad years have entered commercial production. Working off this supply overhang will take time.
Nevertheless, this investment thesis has started to play out for BHP Billiton (ASX: BHP, NYSE: BHP) and Freeport McMoRan Copper & Gold (NYSE: FCX), both of which have delivered double-digit gains since we added these names to the Lifelong Income Portfolio this summer.
But investors worried about missing the boat on these dividend payers and other mining stocks shouldn’t fret.
Valuations remain undemanding in the mining industry, giving investors an opportunity to stock up on the names that stand to benefit the most in 2015 and 2016 from efforts to slash expenses and improve operational efficiency.
Yiannis G. Mostrous contributes his expertise in emerging markets and international equities to Capitalist Times in his Global Top Cat columns.