Stephen Bland puts the big-cap miner through its paces.
In December 2011 I wrote an article on big-cap miner Rio Tinto (LSE: RIO) as a value play, entitled with one of my crummy puns, The Hole Story. It bottom-lined with the view that, at 3,373p, the share was too cheap, particularly on the price-to-earnings (P/E) ratio, which was forecast at only 5.9 for 2012.
Actually, very low P/E was the only value attraction of my four key tests, because it didn't carry my others of P/TB under 1 or net cash or high yield. Behind this was the fact that a few weeks earlier in one of my FTSE 100 value trawls, I found that a surprising six out of the 10 lowest P/E were miners, illustrating just how poorly the market then felt about this important sector of the economy.
We can do without booze, for example -- in theory, at least, that's true -- but we cannot exist without the stuff that miners dig out. Which doesn't mean that their shares are always a good investment, a common fallacy among many naïve investors who feel that necessities make good investment merely because they are necessities. You've got to eat so food producers must be good, right? Wrong. Competition is why.
A little leeway for a big cap
As I've written before, when dealing with big caps I'm prepared to give way on the full works depending on the facts of the case. That's because these are so well researched and discussed that even a single value anomaly like, say, very high yield or very low P/E, as with Rio Tinto, will likely be outed out sooner or later, whereas the market could tolerate that much more in a small cap as a trade-off for its probably greater risk.
The big question though, as with all value plays, is whether the anomaly is really that -- by which I mean an undeserved, sentiment-driven low rating that characterises a value share, or whether it may deserve its cheap consideration by the market. That is what value players have to decide, but it is not necessarily easy and we don't always get it right.
The company has just released 2011 results so I'll do an update. Before I look at all that, note that the price has risen by a useful 13.7% to 3,836p.
Has my version of its value improved? Well, it still has net debt that has more than doubled over the year to $8.5bn at 31 December, so it continues to lack the ideal net cash I like. However, despite the big rise in debt, gearing is still very modest at around 16% of net assets including intangibles. With net tangible assets of $36.4bn, the shares trade at over twice tangible book.
The dividend for 2011 was raised a handsome 34% to 90.47p, but that still makes a historical yield of only 2.4%. Whatever rise may occur in 2012, if any, it is not likely to make Rio Tinto a high-yield share.
One out of four ain't bad
So these three of my value tests still fail, just as I found in my previous article. That doesn't mean that Rio Tinto is a bad share from other investing viewpoints, just that it has not improved on value grounds from how I saw it in December.
Looking at the sole value criterion that caused me to choose it in the first place, P/E, the forecasts for 2012 see earnings per share as fairly flat at around 510p, making a forward P/E of 7.5. That's still modest but less so than in my previous article due to the price rise. So the share has lost some value in the only value feature it possessed in the first place.
I don't do detailed analysis of its mines or markets and so on, and find that such overanalysing, as I call it, does not improve investment selection -- indeed, it may actually worsen it if you are not careful, by forming an attachment to a share that it does not merit. So I'm not going to comment on the prospects for metal prices and so on, because I haven't got a clue.
Giving this some thought for about a millisecond or two, I'm inclined on balance to call Rio Tinto's shares a sell, on the rise in price against the December figure. A quick and certain 13% odd in about 10 weeks or so may be worth having.
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