FTSE 100 commodities giant Rio Tinto (LSE: RIO) has suffered from market uncertainty over China’s economic prospects.
China has been the world’s key buyer of the commodities needed to drive its growth since the late 1990s. However, three years of Covid from early 2020 slowed down its high rate of growth.
Additionally concerning for markets were the high tariffs imposed by the US on its trading partners in April.
That said, I think this could be just the right time for me to add to my existing holding in the firm.
Short-term pain, long-term gain?
As a senior investment bank trader, ‘long term’ could sometimes mean 30 minutes. As a private investor for some time now, it means around 30 years to me!
Over that period, fundamental quality in a firm tends to shine through. And there is plenty of time for transitory shocks in the market or linked to individual stocks to pass.
In Rio Tinto’s case a risk remains that China never fully recovers from the damage done by Covid or tariffs.
But progress has already been seen in its economy. The first quarter of this year saw its gross domestic product (GDP) increase 5.4%. This was ahead of the highest market forecasts for 5%. This was also Beijing’s official target for 2024 – which it achieved – and it remains the target for 2025.
That said, even a 4.5% Chinese GDP expansion is equivalent to adding an economy the size of investment darling India to its own every four years.
On the US tariff threat, May saw Washington lower its levies on China from 145% to 30%.At the same time, China’s retaliatorytariffs on US goods were reduced from 125% to 10%.
How does the share price look?
Rio Tinto’s 8.2 price-to-earnings ratio is bottom of its peer group, which averages 22. These firms comprise BHP at 10.8, Vedanta at 11.9, Antofagasta at 28.9, and Griffing Mining at 36.6.
So it is very undervalued on this measure.
The same is true of its 1.7 price-to-book ratio compared to its competitors’ average of 2.8. And it is also the case with Rio Tinto’s 1.8 price-to-sales ratio against the 2.5 average of its peer group.
I ran a discounted cash flow (DCF) analysis to put these undervaluations into a share price context.
The DCF for Rio Tinto shows it is 41% undervalued at its present price of £42.57.
Therefore, their fair value is £72.10.
The added bonus of a high dividend
In 2024, Rio Tinto paid a total dividend of $4.02, with a sterling equivalent set of £3.10.
This yields 7.3% on the current share price — more than double the FTSE 100’s 3.5% average yield. It is also well over the 4.6% ‘risk-free rate’ (the UK 10-year government bond yield).
My minimum requirement for my dividend stock holdings is a yield of 7%. This comprises the risk-free rate, plus compensation for the additional risk inherent in share investment.
So, Rio Tinto shares still comfortably meet that minimum level for me.
Given their significant undervaluation and their strong yield, I will buy more of the shares very soon.
