Value stocks are companies that have relatively cheap valuations compared to their earnings and long-term growth potential. After a big fall, I think there’s a strong case to be made that Rio Tinto (LSE:RIO) shares are undervalued today.
The company’s one of the world’s largest mining conglomerates with operations spanning iron ore, aluminium, copper, and minerals. China’s ailing economy and falling commodity prices have hurt the FTSE 100 stock recently, but a quality portfolio of assets bodes well for its long-term future.
So let’s explore the outlook for the Rio Tinto share price and whether this could be a good opportunity for me to buy cheap shares today.
Headwinds
There are good reasons to exercise caution regarding Rio Tinto shares. The company’s half-year results were disappointing.
Revenue fell 10% to its lowest level in three years, to $26.7bn, and underlying EBITDA slumped 25% to $11.7bn. In addition, the balance sheet took a turn for the worse as net debt widened by $200m to reach $4.4bn. There was a big blow for passive income seekers too. The company’s proposed dividend of $1.77 represents a 34% fall.
A major reason behind the poor performance is the decline in iron ore prices, considering the company’s the world’s largest producer. The raw material accounts for around 77% of Rio Tinto’s underlying cash profits.
China is the largest source of demand, accounting for around 70% of all iron ore imports. Fears over the health of the world’s second-largest economy have hurt the Rio Tinto share price. They could continue to do so.
Rising youth unemployment, a sluggish construction sector, and the growing probability of a deflationary spiral in China all point to difficult near-term trading conditions for the mining giant.
Taking the long view
However, despite the doom and gloom, there are reasons to be optimistic about the long-term outlook for Rio Tinto shares. The company’s Pilbara network of 17 mines in Western Australia arguably has an equivalent importance to the global iron ore industry as Silicon Valley has to technology. Plus, it’s located in a stable, democratic jurisdiction — often a rarity for commodity operations.
If China manages to revive its economic fortunes, Rio Tinto’s iron ore portfolio is well-placed to benefit. Beijing’s launching fiscal and monetary stimulus programmes, which could mark a turnaround. There’s a real possibility that rumours of the country’s demise could be exaggerated.
Moreover, the company’s making strides to diversify away from iron ore. It has already developed asset strength in aluminium and copper. Lithium is the next metal in its crosshairs. The business is exploring the Jadar deposit in Serbia — Europe’s largest greenfield lithium project.
Should I buy Rio Tinto shares?
I already own a stake in Rio Tinto. My position’s in the red, but I think there’s a good chance the company has entered value stock territory. Although there are considerable risks to bear in mind, the firm’s forward P/E ratio of 8.1 implies better value than the FTSE 100 index as a collective.
Further volatility wouldn’t surprise me, but today looks like an attractive opportunity to buy more shares. When the time comes for me to rebalance my portfolio, Rio Tinto will be near the top of my list of stocks to buy.
