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2 Stock Picks With Miner Advantages

Low-cost resources will allow these basic materials names to maintain their profit margins despite a slowdown in China.

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Elizabeth Collins: We're here today to talk about the basic materials sector. In aggregate, our team here at Morningstar thinks that the basic materials universe is fairly valued. Our price/fair value estimate ratio for the entire sector is 0.97, so it's basically fairly valued. That said, there are a lot of discrepancies by industry and by specific companies, and later on in this segment, I'll tell you about our two top picks in this sector.

But first let me set the stage for you with regard to what's going on in the basic materials sector. And the most important thing we're seeing right now for the basic materials sector is our view that China is slowing down its fixed-asset investment. Many commodities, iron ore, copper, for example, have seen a great boom from China building lots and lots of infrastructure over the past decade, and we think that that is simply unsustainable. And as China moves its economy away from fixed-asset investment and infrastructure and more toward household consumption, investment-led commodities, such as iron ore, will suffer whereas commodities that are more tied to consumption, such as oil or precious metals, will do much better.

Two companies that I'd like to talk about are BHP Billiton and Vale. Both of these companies carry narrow economic moat ratings from us because they have sustainable low-cost advantages. For BHP, it's a diversified miner, and it has advantages in iron ore, petroleum, copper, and coal.

Vale's advantages have more to do with iron ore. I mentioned that we're bearish on the outlook for China's demand for commodities, but we think that the market is overlooking both of these companies' low-cost advantages and the fact that long term their profit margins won't suffer as much because they have those low-cost resources.

Elizabeth Collins has a position in the following securities mentioned above: VALE. Find out about Morningstar’s editorial policies.