Why I'd buy Rio Tinto plc over Sirius Minerals plc
It seems that every few months a new AIM-listed prospective oil driller or miner pops up on the radar of retail investors, tantalises them with tales of striking it rich, then quickly sinks back into the abyss of repeated equity raises, failing to deliver on promised riches and either de-listing or creeping along in perpetual obscurity.
Sirius Minerals (LSE: SXX) is doing its level best to escape this cycle and so far is doing pretty well for a miner yet to, well, mine anything. In June it moved from the AIM to the main market and is now a member of the FTSE 250. It's also moving along nicely by securing planning permission and raising much-needed capital and looks to be on track to meet its target of beginning production in 2021.
However, there are still numerous significant questions that need to be answered before I'd begin a stake in Sirius. The first and most serious is that there is no large and liquid market for the company's product, polyhalite. Management says it is a premium product and sees the potential for it to take market share from traditional fertilisers, but this has yet to be proven on a large industrial scale, and signed off-take agreements have been struck at $145/t, well below spot prices for potash.
Second, the company still needs to raise some $1.7bn in debt to support the project to production. By all accounts this is progressing well, but I'd be leery about buying shares before funding is in place and we know the terms of the agreements.
Finally, there is simply a long way to go before the cash starts flowing. Between now and initial production there are years of construction ahead, including building the highly ambitious tunnel and underground conveyor belt that will move the polyhalite from mine to port. There's plenty that could go wrong in the meantime and with a valuation of £1.2bn, despite being years away from any returns, I'm looking elsewhere for exposure to the commodity sector.
Safe harbour in a turbulent sector?
And my choice in this highly cyclical rough and tumble industry is without a doubt iron ore miner Rio Tinto (LSE: RIO). The company has best-in-class iron and copper mines that kick off massive amounts of cash, it's fast deleveraging its balance sheet and returns gobs of cash to shareholders.
In H1, the company's cost-cutting measures, sale of non-core assets and the recovery in commodity prices led to net cash from operations rising 95% year-on-year (y/y) to £6.3bn. Management is using this cash wisely by investing moderately in production growth, paying down debt to the tune of $2.5bn during the period and then returning the rest to shareholders.
With net gearing down to an industry-beating 13% at period end, management was able to pay out its largest interim dividend in its history this past half year. These returns totalled $3bn and were made up of $1bn in share buybacks and $2bn in dividends that have led analysts to raise full-year dividend yield expectations to 5.7% at today's share price.
Rio Tinto can't control commodity prices, but with low-cost-of-production assets and a healthy balance sheet, management is doing the best it can and shareholders are reaping the rewards of this conservative approach.
But if you can't stand the cyclicality of the mining sector, I recommend checking out the Motley Fool's Top Growth Share of 2017, which has increased sales every year since its IPO in 1997. Best of all, the Fool's Head of Investing sees the potential for its stock to triple in the coming decade.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended Rio Tinto. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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