Rio Tinto (LSE: RIO) has long been a star FTSE 100 stock, but it has fallen over 20% this year. The key reason for this, it seems to me, is the market’s view on the economic recovery in China. As a mining company, Rio Tinto is significantly affected by the level of Chinese demand.
It is true that China has been the biggest global buyer of many commodities since the mid-1990s. It is also true that it experienced three years of subdued economic activity during its peak Covid years.
However, China now appears to be recovering soundly. I also think that many analysts are wrong in their predictions about what this recovery will involve for commodities’ prices.
The nature of China’s recovery
China’s stellar economic growth from the mid-1990s to before the Covid pandemic hit in 2020 fuelled the ‘commodities supercycle’. This supercycle featured ever-rising prices for commodities that were key to its economic growth.
The main economic driver for much of that time was a huge expansion in manufacturing. And this required the use of lots of different commodities, from oil to copper to iron ore. Rio Tinto is a major player in the latter two, among many other commodities.
The next phase of China’s economic development was focused on the dramatic expansion of the middle class. This was characterised by a massive surge in consumption-led demand for goods and services. This phase did not rely so heavily on manufacturing and has seen a decline in Chinese demand for some of what firms like Rio Tinto produce.
And currently, many analysts believe that China’s economic rebound will not be of the sort that will boost commodity prices quickly.
This may be true. But I think China’s economic rebound will broaden out into areas that boost these prices. And I think that will happen sooner than many analysts believe. After all, China’s President Xi Jinping has a lot at stake personally to ensure that China’s economic rebound exceeds expectations.
Not just a big-picture play
These big picture factors aside, I believe that Rio Tinto as a company has a lot to recommend it. Broadly, its 2022 results were down on the previous year’s. But it still delivered underlying EBITDA of $26.3bn, and free cash flow of $9bn.
It also posted underlying earnings of $13.3bn, and an underlying return on capital employed of 25%. This latter figure is way higher than the industry average of around 13%.
Additionally, Rio Tinto remains committed to delivering excellent returns to shareholders. For 2022, it paid a total dividend of $8bn. This represents 60% of its underlying earnings, which is a company policy. It also meant a dividend yield of 6.8%. For 2021, the payout was 13%, and for 2020 and 2019 it was 6.8%.
For me, the key risk here is that China’s economic recovery falters. This would mean demand for commodities staying lower for longer and prices staying lower too. Rio Tinto does operate in many countries, but Chinese demand remains a big component of all firms in the sector.
This said, for me, it offers high growth potential and high dividends at a knockdown share price. And if I did not already have other holdings in the sector then I would buy it right now.
