Why Rio Tinto plc Is So Cheap

When I look around the FTSE 100 (FTSEINDICES: ^FTSE), there are some shares that just look too cheap on P/E valuations.

Rio TintoOne of them is Rio Tinto (LSE: RIO) (NYSE: RIO.US), which has actually seen its share price gain 15% over the past 12 months.

But over five years, the Rio price has lagged the FTSE with a rise of only 20% compared to the index’s 55%. And with a small fall in earnings per share (EPS) forecast for this year followed by a 14% rise in 2015, the shares are on a low P/E of 10 for 2014 dropping to under nine for the year after.

High dividend, low valuation

A stock offering dividend yields of around 4%, but priced at a 40% discount to the FTSE’s long-term average P/E of 14 — why is that?

The mining business tends to be cyclical, with world economic cycles driving commodities prices up and down, and that in turn giving the miners erratic profits from year to year.

And then there’s China, whose economic growth is cooling a little, and that has led to fears of a slowdown in demand for metals and minerals.

But does that all justify the low valuation of the miners in general, or of Rio Tinto specifically?

No, I don’t think it does and here’s why:

Firstly, China’s “slowing” economy is still growing at around 7.5% per year — with the World Bank predicting 7.4% as far ahead as 2016!

China still strong

There are fears that China’s booming credit market could come to an abrupt halt, and property prices have already shown signs of faltering. But the Chinese government is trying to bring about a transition right now, to move from government-led growth to more of a private market economy. In the long term, that has to be a good thing, and now could well be the best time to do it — and it has to be good for commodities demand.

Secondly, Rio Tinto is unearthing record amounts of precious dirt — and selling it all! Fears have been voiced of overproduction leading to a glut, especially of iron ore.

But Rio’s first-quarter update in April told us of record iron ore production — and shipments! The company dug up 66.4 million tonnes of the stuff in the period, up 8% on the same quarter a year previously — and it shipped 66.7 million tonnes, for a rise of 16%. It seems the world can’t get enough iron.

We also heard of record bauxite production — and shipments. And Rio is producing higher grade copper these days, resulting in a 17% rise to 156.6 thousand tonnes.

Great forecasts

The City’s analysts are predicting several years of steady earnings and rising dividends, and are sitting on one of the strongest sets of Buy recommendations out there.

Rio Tinto’s low P/E valuation does seem to be riding on those Chinese fears — but I reckon they’re overdone.

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Alan does not own any shares in Rio Tinto or Tesco. The Motley Fool owns shares in Tesco.