Rio Tinto (LSE: RIO) and its iron ore operations have been back in the headlines on Wednesday on news that the firm’s investing a cool $749m in one of its assets in Pilbara, Western Australia. The programme will allow the FTSE 100 miner to plough new and existing deposits at its Greater Tom Price facility, plans which also include the creation of a new crusher and 13-kilometre-long conveyor.
Quite a vote of confidence in the health of the iron ore market, I’m sure you’d agree. But I’m not encouraged by the market outlook for the near term and beyond. A swathe of new projects and upgrades to existing facilities, not just by Rio Tinto but mining firms all over the globe, threatens to keep the market swamped in a growing state of oversupply well into the next decade.
China in the crosshairs
It’s a topic that has caused prices of the steelmaking ingredient to whipsaw all over the place in recent times, though with key economic releases from Chinese industry getting worse and worse, prices have got demonstrably worse too.
Signs of cooling crude steel production in the Asian nation caused iron ore values to slump below the psychologically-critical $80 per tonne marker last week — total output dropped 1.2% in October, the first drop for almost two years — and fresh industrial data released today heaped further pressure on prices.
According to official data, Chinese factory profits tanked 9.9% last month, worsening considerably from the 5.3% drop endured in September. This was also the worst result since the start of 2019.
As a reflection of these declining gauges, many commodities commentators expect iron ore prices to deteriorate sharply over the medium term. The boffins at Morgan Stanley, for example, expect the cost of the raw material to steadily deteriorate in 2020, averaging 79 bucks per tonne versus 94 bucks in 2019. And things are tipped to get worse thereafter, an average of $68 tipped for 2021 and the long-term target set at $61.
Worth the risk?
Despite the increasingly cloudy outlook for the Chinese economy, and by extension prices of iron ore and other industrial commodities for 2020 and beyond, Rio Tinto’s share price has continued to defy gravity. In fact, the mining giant’s share price has gained 9% in value over the past three months.
There’s only so long the company can remain resilient despite the clear deterioration in market conditions and I fear the comedown could be catastrophic. City analysts continue to downgrade their profits estimates for Rio Tinto for next year, meaning that the 13% drop currently estimated is not likely to be the last negative revision.
It’s why I’m not tempted to buy into the business, despite its rock-bottom forward P/E ratio of 8.8 times and its 8.2% corresponding dividend yield. There’s a galaxy of brilliant big-yielding stocks to buy on the FTSE 100 today. My advice, then, would be to give Rio Tinto a miss and put your money to better use elsewhere.
