It's not every day you see analysts initiate coverage on BHP Billiton or Rio Tinto. But RBC Capital analyst Paul Hissey has done just that – and backed the beleaguered BHP over its big rival.
Mr Hissey said Rio's position as the stand-out performer among the mining majors was "likely coming to an end".
Rio was slapped with an "under-perform" rating and a target price of $37, down from its current price of $41.53. BHP was given a "sector perform" rating and a $15 target price, slightly less than its current price of $15.67.
"Rio's concentration of profitability in the structurally challenged iron ore division will likely see Rio's relative flexibility erode the most over the coming 12 months in the absence of a price rally," Mr Hissey said.
The "challenges facing the rest of the industry could take hold there [at Rio] too", he said, noting the miner was not likely to cut its dividend at its full-year result this week.
The Australian Financial Review flagged earlier this week that Rio was likely to announce a review of its $US4.1 billion ($5.8 billion) dividend at its results this week, and to cut it heavily as early as August.
Mr Hissey said he expected BHP to cut its annual $US6.6 billion dividend payout by 75 per cent at its interim results in February, to create flexibility and stave off more credit downgrades. Most analysts are expecting about a 50 per cent cut.
'Forced first mover'
He prefers BHP to Rio as a "forced first mover" on capital management.
"Our preference for BHP is predicated on the degree of underperformance that we have observed against Rio, the greater diversification despite the travails of oil, and the likelihood that BHP will be forced to act sooner in revising its dividend policy, which would provide greater cash flow on a one- to three-year view.
At the same time, deterioration in iron ore prices could move Rio's net debt to earnings before interest, tax, depreciation and amortisation to levels "not dissimilar to Glencore", he said.
"All of this follows a sharp period of outperformance by Rio versus the rest of the broader global diversified miners."
Large diversified miners were exposed to further erosion in cash flow and balance-sheet strength, he said. Demand outlook across the main commodities looked "opaque", with risks of getting worse.
RBC had more hope of an oil price recovery than in iron ore, he said.
"Medium term, we are more constructive on the potential recovery in oil markets, [favouring BHP], although this too will likely result in increased capex."
Wary of false dawns
Mr Hissey also warned investors to be wary of false dawns.
"The near term is likely to [continue to] be a painful exploration of corporate discomfort. The near term may also see short, sharp rallies, requiring tactical positioning from investors."
That should throw up significant opportunities for the companies with the healthiest balance sheets.
What RBC would need to see before value appeared in the mining sector was macro stability, greater visibility in Chinese demand, acceptance by companies that current debt and dividend structures were unsustainable and eventual supply reductions, he said.