The Pros And Cons Of Investing In Rio Tinto plc

Making stock market selections are never black-and-white decisions, and investors often have to plough through a mountain of conflicting arguments before coming to a sound conclusion.

Today I am looking at Rio Tinto (LSE: RIO) (NYSE: RIO.US) and assessing whether the positives surrounding the firm’s investment case outweigh the negatives.

Production rattles higher

Rio Tinto’s bubbly production report in October boosted market optimism over the firm’s earnings growth, and prompted the miner to upgrade its output targets for the current year.

Total copper production surged 23% during July-September, to more than 162,000 tonnes, as operations at Rio Tinto’s gigantic Oyu Tolgoi mine ramped up and its Kennecott Utah facility outperformed. The firm now expects full-year output to come out at 590,000 tonnes. Elsewhere, iron ore output clocked in at a quarterly record of 64.3 million tonnes due to production improvements and new capacity coming online.

Divestments continue to drag

Last month’s update also highlighted the progress the firm has made in stripping costs out of the machine, although the firm’s transformation drive following the 2008/2009 financial crisis has proved less successful in terms of asset sales.

Rio Tinto’s plan to repair its battered balance sheet by initiating the sale of numerous projects has failed to fire into life, as exemplified by the aborted divestment of its Iron Ore Company of Canada and Pacific Aluminium divisions. As capital expenditure looks set to remain tight across the mining sector, and prices for such assets continue to tumble, Rio Tinto could struggle to shed itself of these items.

A cheap cyclical choice

But if you are a believer in the long-term outlook for commodities demand, then Rio Tinto could be considered an excellent way to tap into the mining sector at a great price.

In this respect you wouldn’t be alone, and shares in the company have risen more than a quarter from June’s four-year troughs around 2,600p. Even so, Rio Tinto still offers great value for money based on current broker projections, and carries a P/E multiple of 10.5 and 9.1 for 2013 and 2014 respectively. These readings are camped around the benchmark of 10, marking the stock as an attractive value pick.

Demand remains dire

Still, investors should be aware of the significant supply/demand imbalances that exist in many of the firm’s key markets — particularly in the critical iron ore space — and which are in severe jeopardy of worsening as the global economic recovery struggles to gain traction.

Indeed, news that growth in the key end-markets of Europe continues to flatline does not bode well for prospective demand levels — eurozone GDP rose just 0.1% during July-September, down from a 0.3% expansion in the previous quarter and again raising fears of deteriorating economic conditions in the region.

An underwhelming share selection

So, in my opinion, the risks attached to Rio Tinto far outweigh the potential rewards. The firm’s great production profile counts for little if end-demand is weak and commodity prices remain on the back foot. I believe that the prospect of further turbulence in the global economy remains could once again prove catastrophic for the mining firm’s earnings outlook.

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> Royston does not own shares in Rio Tinto.