Can BHP Billiton Outperform Cliffs Natural Resources?

LONDON -- If you're interested in building a profitable, diversified portfolio, then you will often need to compare similar companies when choosing which share to buy next. These comparisons aren't always as easy as they sound, so in this series, I'm going to compare some of the best-known names from the FTSE 100, FTSE 250 and the U.S. stock market.

I'm going to use three key criteria -- value, income and growth -- to compare companies to their sector peers. I've included some U.S. shares, as these provide U.K. investors with access to some of the world's largest and most successful companies. Although there are some tax implications to holding U.S. shares in a U.K. dealing account, they are pretty straightforward and I feel are outweighed by the investing potential of the American market.

Today, I'm going to take a look at global mining giant BHP Billiton (BHP) (BBL) and its much smaller, US-based peer Cliffs Natural Resources (CLF 0.81%), which is the largest producer of iron ore in the U.S. and has an Australian mine that exports iron ore to China, in competition with BHP.

1. Value
The easiest way to lose money on shares is to pay too much for them -- so which share looks better value, BHP Billiton, or Cliffs Natural Resources?

Both companies have been hit by a run of falling earnings over the last twelve months, although for different reasons. BHP's highly profitable petroleum division has helped it avoid an outright loss, as have its exceptionally low cash costs per tonne of iron ore extracted. Cliffs Natural Resources has higher cash costs in its iron ore mines and has also experienced similar price pressure in its coal division, pushing it to an overall loss.

In pure value terms -- based on the companies' price to book ratios -- Cliffs has more to offer, but the company's smaller size, high costs and substantial debts mean that it is much more vulnerable to falling iron ore prices.

2. Income
With low interest rates set to continue for the foreseeable future, dividends have become one of the most popular ways of generating an investment income. How do BHP Billiton and Cliffs Natural Resources compare in terms of income?

BHP Billiton's forecast yield of 4% is remarkably high for a big miner, and indicates the growing trend in the industry to focus on shareholder returns. I think BHP is a clear winner in the income category, due to its size, underlying profitability and the safety of its dividend.

Cliffs Natural Resources has also been focused on delivering strong dividend growth in recent years, but when its published its full-year results in February, it announced a 76% cut to its quarterly dividend, which was reduced to $0.15 per share. Shortly after, it announced a $1 billion share offering to shore up its finances -- this isn't a very safe dividend.

3. Growth
Even if your main interest is value or income investing, you do need to consider growth. At the very least, a company needs to deliver growth in line with inflation -- and realistically, most successful companies need to grow ahead of inflation, if they are to protect their market share and profit margins.

How do BHP Billiton and Cliffs Natural Resources shape up in terms of growth?

Cliffs' growth fell off a cliff in 2012, as earnings per share dropped from $11.48 to a loss of $6.32 per share. The decline was primarily due to weaker iron ore and coal prices caused by ample supply and moderating demand. Cliffs has already suspended operations at its iron ore pellet plant in Canada, and its Australian mine has much higher costs than the large mines operated by Rio Tinto and BHP Billiton in the same region.

I don't think we've seen the end of Cliffs' troubles, and I believe that despite its size, BHP Billiton may offer better growth prospects over the next few years.

Should you buy BHP Billiton or Cliffs Natural Resources?
I originally thought that Cliffs Natural Resources might be able to benefit from its smaller size to deliver more significant growth than BHP Billiton over the next few years. However, having spent some time looking at the company's figures, I'm concerned. Although the Cliffs' U.S. iron ore operations have more competitive cash costs and benefit from a captive domestic market, its Asia-Pacific operations seem outclassed by its lower-cost, larger competitors, and Cliffs' U.S. coal also looks expensive.

My choice for income and growth would be BHP Billiton, and while Cliffs Natural Resources may technically offer better value, I think it carries too much risk and debt, and too little potential reward.

2013's top income stock?
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