Rio Tinto Plc Still Has Iron In Its Soul

Rio Bravo

Suddenly, everybody is bullish about the miners. The mood shift took me by surprise, because I have been fixating on the prospect of a Chinese meltdown. But it is good news for investors in Rio Tinto (LSE: RIO) (NYSE: RIO.US), who have been through a rocky time lately. Its share price is down 23% over the past three years, but has now climbed 11% over the last six months. Is now the time to buy, before it climbs higher?

Long-term investors won’t need reminding that Rio Tinto has iron in its soul. Or rather, iron ore, which makes up a mighty 89% of its earnings. It produced more than 70 million tonnes in the fourth quarter, up 6%, and 266 million tonnes over the full year. Steelmaking coal, bauxite and copper production also ramped up.

Chief executive Sam Walsh’s cost-cutting campaign continued apace, with an extra $2 billion of operating cash cost improvements in 2013. Exploration and evaluation spend was also down more than $1 billion, exceeding the target $750 million. Rio also announced $3.5 billion of non-core asset divestments and completed $2.5 billion of them. I applaud Walsh’s strategy. Rio might need a financial cushion, given latest news from China.

Steel Crushes Iron

The iron ore price has just dropped to a six-month low as China, which makes up 60% of global demand, heads into its New Year holidays with its steel mills fully stocked. After trading at up to $140 a tonne, the price has slipped to around $124. Credit Suisse even suggested the price could slip to $100, as steelmakers de-stock to protect fragile margins. Last time commodity prices fell sharply, in 2012, Rio suffered its first full-year loss for 18 years. 

I remain a little baffled by all the bullishness about the miners. HSBC has just lifted its target price to 4060p, up from 3850p, and remains overweight. Today you can buy it for 3225p, comfortably below that valuation. Ramping up production won’t help miners if demand is falling, it will only make matters worse. Chinese GDP growth is still a healthy 7.7% a year, but the authorities are battling to tighten its breakneck credit expansion, and that could hit  growth. Latest HSBC/Markit PMI date for Chinese manufacturing showed an unexpected contraction from 50.5 to 49.6 this month.

Then again, if every potential macro meltdown stopped you from buying good companies at attractive prices, your portfolio would be empty. Rio trades on a p/e of 10.7, forecast to fall to just 9 times in December 2014, so much of the current uncertainty seems to be priced in. 

Earnings per share are forecast to grow a healthy 16% this year and 11% in 2015. The slightly disappointing 3.1% yield is covered three times, giving scope for growth. If you’re happy having so much exposure to China, now looks an attractive time to buy.

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> Harvey doesn't own shares in Rio Tinto.