How Much Lower Can Rio Tinto plc Go?

Right now I’m looking at some of the most popular companies in the FTSE 100 and wider market to try and establish in which direction their shares are likely to move.

Today I’m looking at Rio Tinto (LSE: RIO) (NYSE: RIO.US) to ascertain if its share price will continue to fall.

Market sentiment
Rio Tinto

For the first few months of this year, Rio could do no wrong and the company became a darling of both the City and investors.

Indeed, after reporting a record level of output during 2013, many in the City believed that the company was set for a record 2014 as profits surged, debt fell and the company hiked its dividend payout by 15% — there was even talk of a share buyback.

But this optimistic view has since evaporated, as the price of iron ore has slumped 26% year to date and there is talk that it could fall further.  As a result, the market has taken a cautious stance with regards to Rio’s outlook and many City analysts have revised their earnings forecasts for the company lower.

Still, Rio continues to cut costs and capital spending across its portfolio, which should, to some extent, offset the declining iron ore price.

In particular, the company is targeting a $3bn operating cash cost improvement during 2014. Additionally, capital spending this year is expected to be less than $11bn, down from the figure of $13bn reported during 2013, falling to $8bn during 2015. During the first quarter of this year exploration spending fell nearly 50% year on year to $155m.

Further, the company’s net debt fell to $18bn at the end of 2013, down around $4bn, and this smaller debt burden should reduce the company’s interest costs. 

Possible catalysts

Of course, Rio’s main catalyst going forward will be the price of iron ore. Unfortunately, with the commodity’s price recently crashing through the physiological $100 per tonne level, many within the iron ore industry are starting to worry.

Indeed, iron ore is now trading at a low not seen since 2012 and it’s expected that the commodity’s price could fall further as Chinese demand for steel slackens.

According to Goldman Sachs, which has assumed the ‘worst case’ scenario, the price of iron ore could fall as low as $80 per tonne during the next year or so, a full 41% below the high of $135 per tonne seen at the end of last year. It’s not unreasonable to assume that Rio’s earnings will fall by a similar amount. 

City expectations

With the low price of iron ore overshadowing Rio, it’s no surprise that the City has turned against the company during recent weeks.

City analysts now expect Rio to report earnings per share of 320p for 2014, down from the figure of 350p previously expected. This lower estimate puts the company on a forward P/E of 10.1. Additionally, the City’s figures show that the company will offer a 3.8% dividend yield for this year.

However, these forecasts are subject to downward revisions if the price of iron ore continues to slide. 

Foolish summary

Overall, Rio looks cheap but until the price of iron ore recovers, the company’s shares are likely to remain depressed.

All in all, I feel that Rio’s shares will continue to fall. 

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Rupert does not own any share mentioned within this article.