86 Reasons Why Rio Tinto plc Is A Dicey Stock Selection

In this article I am looking at what a worsening iron ore market means for mining giant Rio Tinto (LSE: BLT) (NYSE: BBL.US).

Iron ore prices continue to slide

An environment of worsening oversupply continues to plague the iron ore market, putting the price prospects for the steelmaking ingredient under mounting pressure.

rio tinto

These fears were stoked further this week when the Australian Treasury released its Budget, predicting that realised iron ore prices are set to steadily erode over the coming months and hit 92 Australian dollars (A$) per tonne — that’s 86 US dollars (US$)  at current exchange rates — by next June.

Prices are expected to continue rattling lower thereafter, and are predicted to fall as low as A$87 (or US$82) by June 2016.

Brazilian mining colossus Vale SA — far and away the world’s largest producer of iron ore and pellets — reported last month that realised iron ore prices collapsed to US$90.5 per tonne during January-March from US$113 in the previous three months. The result of such escalating price pressure pushed operating profit to US$3.9bn from US$5.2bn during the corresponding 2013 period.

Rio Tinto’s heavy reliance on a healthy iron ore price threatens to wreak havoc on its own earnings. The business, which sources around 77% of total earnings from the market, has so far managed to avoid the effects of consistent price pressure and keep earnings ticking higher by means of strict cost-cutting and reduced capital expenditure. Indeed, Rio Tinto saw underlying earnings rise 10% last year to US$10.2bn.

But Rio Tinto continues to churn out more and more iron ore, a situation which could seriously offset savings elsewhere should ore prices continue to collapse. Boosted by ongoing expansion at its Pilbara operations in Australia, the firm pumped out a record 266m tonnes of material during 2013, up 6% from the previous year.

And elsewhere, BHP Billiton reported in April that output during the nine months to March hit a record of 147m tonnes, prompting the firm to upgrade its full-year production guidance to 197m tonnes. And Vale also recently announced that iron ore output hit 71.1m tonnes during January-March, the best quarterly performance since 2008.

With miners across the globe set to continue aggressively ramping up iron ore production, levels of which continue to far outstrip projected demand levels, I believe that Rio Tinto could be set to experience significant earnings weakness in coming years.

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Royston does not own shares in any of the companies mentioned in this article.