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Should I buy Rio Tinto shares?

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Diggers and trucks in a coal mine
Image source: Getty Images.

Mining stocks are once again back in favour. Rio Tinto (LSE: RIO) shares rose about 75% in the past year. These returns are very good, as the FTSE Index rose only about 5% in the same period.

As an investor, I cannot rely only on past returns. I would like to understand the current prospects of this mining giant.

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Fundamental analysis 

Rio Tinto’s revenue has been growing at a steady pace in the past few years. More importantly, in the recent year 2020, it grew by 3.3% year-over-year to $44.6bn. The growth rate is slower than over the historical period. However, I think the growth rate is good taking into consideration the disruptions caused by Covid-19. 

The company’s profits have also grown. In the year 2020, profits grew by 49% year-over-year to $10.4bn. The underlying EBITDA (earnings before interest, taxes, depreciation, and amortisation) grew by 13% year-over-year to $23.9bn. The company’s low-cost portfolio and long-life assets have helped to deliver superior returns.

The cash flows also play an important role. Free cash flow was $9.4bn in the year 2020. This is another reason why I like Rio Tinto shares. The company had positive free cash flows in each of the past five years. Another positive point is that the company was also able to reduce its debt. Net debt was $664m in the year 2020 when compared to $3.7bn in the previous year.

I also appreciate the stock for having consistently paid good dividends. In the most recent year, it declared a total dividend of $5.57 or £4.08 per share for the year 2020. However, a point to note is that it includes a special dividend of $0.93 or 66.77p — and the company’s future dividends are not guaranteed.

Looking into the company’s segments, iron ore accounted for about 58% of total 2020 revenue. However, it accounted for 76% of the total underlying EBITDA. The higher profits were due to higher realised iron ore prices helped by strong demand from China. 

Risks to consider in investing in Rio Tinto shares

Rio Tinto’s management has been criticised for the blasting of an Aboriginal cave in Australia. Chairman Simon Thompson resigned over the Juukan Gorge destruction. Last year, the CEO and several top executives resigned as they took responsibility for failing to protect the archaeological research sites. This event could add additional costs to the company. Investor groups have also expressed their strong concern in this regard and it might have a negative impact on the shares of the company.

The mining industry is heavily regulated. It has to comply with various environmental and government. This could impact the company’s future operations. Also, it is a capital-intensive industry. Not all mines will be profitable. The company had a $14bn write-down in the year 2013. It was largely related to the Alcan acquisition in 2007.

Final view on Rio Tinto shares

Rio Tinto shares are currently trading at a price-to-earnings ratio of 9.9 which I believe is a value buy. The company also has stable cash flows. Lastly, it is a large-cap with diversified mining operations. I certainly prefer the company when compared to another mining stock I reviewed last month.

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Royston Roche has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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