First-half results released by Rio Tinto (LSE: RIO) on Wednesday showed that the mining company is making strong progress. Its share price has already beaten the FTSE 100 by 5% since the start of the year, and more outperformance could be ahead.
Encouraging period
In the first half of the year, Rio Tinto was able to generate operating cash flow of $6.3bn. The company’s cash flow benefitted from the achievement of $2.1bn of pre-tax sustainable operating cash cost improvements in 2016 and in the first half of the current year. In achieving this, the company has now reached its target in this area around six months ahead of schedule. This is encouraging news for its investors, since it is now markedly more efficient and potentially more resilient towards commodity price declines than it was even just a few years ago.
The company’s financial performance in the first half of the year also allowed it to reduce net debt by $2bn so that it now stands at $7.6bn. This further strengthens its financial position and means that its balance sheet is less risky than it was previously. At the same time, the company has been able to strengthen its portfolio, with all three growth projects on track. Its underlying earnings of $3.9bn and a return to shareholders of $3bn through a mix of dividends and share buybacks show that the business remains relatively sound at a time when the mining industry still faces considerable risks over the medium term.
Growth potential
Rio Tinto’s strong performance in the first half of the year means that it is on track to meets its forecasts for the full year. It is expected to record a rise in earnings of 54%, which puts it on a forward price-to-earnings (P/E) ratio of just 10.5. This indicates that it offers a wide margin of safety at a time when a number of mining companies have seen their valuations rise during the course of the last year. As such, it could offer good value for money when compared to sector peers.
In fact, fellow mining company Glencore (LSE: GLEN) has a forward P/E ratio of 13.2. This suggests that Rio Tinto is undervalued when compared to its sector peer. Certainly, Glencore may be a better diversified business which has an asset base which is arguably more attractive than that of its sector peer in terms of breadth of operations. However, with Glencore lacking the financial strength and income potential from an investment perspective of its resources rival, it seems to lack the same scale of investment potential as Rio Tinto at the present time.
Risk/reward
Of course, both stocks appear to offer strong growth potential for the long term. But as its results today show, Rio Tinto has a potent mix of low risks from its strong cash flow and improving business model, as well as a low valuation and high dividends. This creates a favourable risk/reward ratio which could mean it keeps beating the FTSE 100 in future.
