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The Contrary Investment Case: 3 Reasons Why Rio Tinto plc May Be A Strong Buy

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In recent days I have looked at why I believe Rio Tinto (LSE: RIO) (NYSE: RIO.US) could be headed for the downside (the original article can be viewed here).

But, of course, the world of investing is never black-and-white business — it take a confluence of views to make a market, and the actual stock price is the only indisputable factor therein. With this in mind I have laid out the key factors that could, in fact, make Rio Tinto a shrewd addition to your shares portfolio.

Steel demand poised to tick higher

Rio Tinto derives around nine-tenths of group earnings from iron ore, making it particularly susceptible to the market’s weak fundamentals as a glut of supply continues to march on board. However, many believe that improving macroeconomic conditions — and crucially a resurgence in global construction activity — should mitigate the market imbalance as steel demand accelerates.

A recent survey conducted by the Financial Times showed that steel analysts expect global output to rise 3.6% during 2014, with a sharp snapback in European production set to outstrip planned curbs at Chinese mills. Meanwhile, signs that Beijing is failing to adequately implement planned plant closures could push these projections still higher. This positive outlook follows the 3.5% uptick in smelting activity seen last year, according to World Steel Association numbers.

Iron ore woes already priced in?

Even for those who believe that steel production over the medium term will fail to adequately mop up the vast amounts of iron ore floating around the system, it could be strongly argued that an uncertain outlook for the steel-making ingredient is already factored into Rio Tinto’s current trading price.

With earnings expected to rise 8% in 2014 and 9% in 2015, this leaves the mining giant changing hands on P/E ratings of 9.5 and 8.7 for these years, comfortably below the value benchmark of 10 and providing a meaty discount to the entire mining sector’s forward average of 18.8.

Restructuring continues to deliver

Rio Tinto has undergone a vast transformation programme in recent years to deliver a more streamlined, earnings-creating machine. And the firm’s finals last month showed the terrific progress which these measures are making — operational cast cost improvements of $2.3bn last year vastly exceeded the company’s original $2bn target, and more is pencilled in to come.

As well, the mining giant remains active in stripping out non-core assets in order to bolster its already-sizeable cash pile, and generated $2.5bn through a variety of disposals made during the last year. Rio Tinto is also drastically scaling back capital expenditure across its operations, with such outlay falling 26% in 2013 alone to $12.9 billion. With commodity markets set to remain under the cosh for some time, these expense-slashing steps are essential to deliver earnings growth.

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> Royston does not own shares in Rio Tinto.