Critics of Rio Tinto (LSE: RIO) (NYSE: RIO.US) point to the fact that it remains almost completely dependent on iron ore — but they’re missing the point.
Rio’s iron ore mines are some of the largest, cheapest and most modern in the world — and they’re located in a politically stable jurisdiction, Australia.
By investing in Rio today, you’re effectively buying shares in a giant, highly-profitable iron ore miner, with options on aluminium, copper and coal. In my view, it’s an attractive deal, as I’ll explain.
1. 67% profit margin
Last year Rio reported earnings before interest, tax, depreciation and amortisation (EBITDA) of $17.4bn on iron ore sales of $26bn — effectively a gross profit margin of 67%.
Rio bears say that the firm will suffer from falling iron ore prices, thanks to a surge of new capacity hitting the market.
I’m not so sure: much of the new capacity comes from Rio itself, and I believe the firm’s board has decided it can make more money from selling more iron ore, even if it is at a slightly lower price.
Rio has just completed a project to increase the throughput of its Pilbara iron ore operations from 225 million tonnes per annum (Mt/a) in 2011 to 290 Mt/a, and is targeting a final rate of 360 Mt/a by the end of 2017.
Rio’s figures suggest its iron ore mining costs are around $40 per tonne — amongst the lowest in the world. Given that iron ore currently trades at more than $100 per tonne, EBITDA could rise to more than $21bn as production continues to rise.
2. 7% dividend growth
Rio’s high profit margins mean it generates a lot of cash, an increasing amount of which is being returned to shareholders.
Analysts are currently forecasting a 7% dividend increase in both 2014 and 2015, giving Rio shares prospective yields of 3.8% for this year, rising to 4.1% next year.
3. $27,997m
Iron ore accounted for 96% of Rio’s underlying post-tax earnings last year, but less than half of its turnover: in addition to $25,994m of iron ore sales, Rio sold $27,997m of aluminium, copper, coal, diamonds and other minerals.
Although profits remain relatively poor from these divisions, this situation is unlikely to last forever — hence my view that when investing in Rio, you are buying a world-class iron ore miner, with a free option on several other key commodities.
