These days almost everybody has nice things to say about mining giant Rio Tinto (LSE: RIO) (NYSE: RIO.US).
Deutsche Bank, Citigroup, Jefferies, Canaccord Genuity and other brokers all have it as a ‘buy’. Credit Suisse, Exane BNP Paribas and RBC Capital Markets prefer ‘outperform’.
The bullish consensus is clear, and it surprises me, because I thought Rio was in for a tough time.
Don’t Blame It On Rio
If everybody is buying Rio Tinto, why aren’t I? I certainly don’t have a problem with the company, what it does, or the quality of its management. My are focused on the wider problem of China.
Rio generates roughly 90% of its earnings from iron ore. With China accounting for up to 60% of global or demand, that makes Rio heavily exposed to the fortunes of the world’s second-largest economy.
Supply Shock Looms
As the Chinese authorities look to switch from an export-led to a consumption-driven model, I expected a slump in the iron ore price and demand.
And to a degree, I’ve been right. Iron ore started the year at $128 per metric ton. Lately, it has fallen to around $93, largely due to oversupply, with both Rio and fellow miner BHP Billiton both pumping up production this year.
China can’t keep absorbing endless supply. I remain convinced that its demand for steel will eventually plateau, as its credit-fuelled property and infrastructure boom finally tops out.
The patchy recovery in the US and looming deflation in Europe will also prove to be headwinds for the mining sector. Anglo American confessed to struggling with softening demand in the first half of the year.
Yet still people are buying Rio.
Chinese Arithmetic Adds Up
One reason is that Chinese economic data has been more positive than worriers like me expected. Consumer price inflation fell to 2.3% in July, well below the government’s 3.5% target, which should help keep monetary policy easy.
Better still, Chinese exports leapt 14.5% in the year to July. Manufacturing rose at the fastest pace in two years.
The game isn’t up in China yet.
Rio Shows Brio
While I fretted about China, Rio was getting down to business. Last week, it posted an impressive 21% rise in first-half underlying earnings, to $5.1 billion.
Operating cash rose 8%, and it beat its $3 billion cost reduction targets six months early. Capital expenditure almost half to $3.6 billion, year-on-year. Net debt is down to $16.1 billion, against $22.1 billion one year ago.
These figures are a very sound reason to buy Rio Tinto right now. No wonder the share price is up nearly 10% in the last month.
Dash For Cash
Here’s another reason to rock with Rio. Management has just increased its interim dividend by a highly progressive 15% to 96 cents per share. That puts it on a forecast yield of 3.7% for December, rising to 4% for December 2015.
Chairman Sam Walsh reckons Rio should continue to generate strong and sustainable cash flows over the coming years, which “will result in materially increased cash returns to shareholders”.
I like the sound of that.
And at today’s valuation of 10.7 times its (colossal) earnings, you aren’t overpaying for the stock either.
Now I see why everybody is buying Rio today. Maybe it’s time to join them.
