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Will Rio Tinto plc Become A Disastrous Value Trap?

Today I am looking at whether now is the time to do some bargain hunting by stocking up on Rio Tinto (LSE: RIO) (NYSE: RIO.US).

A well-priced growth AND income pick

On the face of it, diversified mining giant Rio Tinto’s share price appears to be too good to be true. During the course of a tumultuous 2014 the business has shed more than 16%, with fears of growing oversupply across key markets prompting concerns of further commodity price weakness next year and beyond.

Against this backcloth Rio Tinto is expected to punch heavy 12% earnings declines during each of the next two years. Given these concerns the company fully deserves to be trading on ultra-low earnings multiples, and it could be argued that the massive risks facing Rio Tinto are right now baked into the price — indeed, P/E readouts of 8.6 times and 9.4 times for 2014 and 2015 correspondingly fall well within the bargain territory of 10 times or below.

On top of this, Rio Tinto’s heavy price descent also presents dividend yields comfortably above the current 3.3% FTSE 100 average. The fruits of significant capex reductions, ongoing asset shedding and extensive cost-cutting are expected to deliver chunky dividend advances this year and next, resulting in lip-smacking yields of 5% for this year and 5.4% for 2015.

… but are forecasts set for renewed pressure?

However, I believe that Rio Tinto — like the rest of its mining sector peers — remains a high-risk stock selection that could disappoint bargain chasers should fresh earnings downgrades materialise.

Firstly, questions over the health of the Chinese economy continue to mount, with industrial output still sagging and forecasts for natural resources demand subsequently darkening. Just this month, the People’s Bank of China warned that it expects GDP growth to slow to 7.1% next year on the back of a cooling property sector, down from an expected 7.4% in 2014 and marking a huge departure from an expansion of 7.7% recorded last year.

News of sagging construction activity comes as a particular concern for Rio Tinto, which generates around three quarters of all profits from the critical steelmaking ingredient iron ore. Meanwhile the implications of fiscal stress in the eurozone also threatens to derail finished goods demand in this region, further smacking commodities demand.

Despite these worries, however, Rio Tinto and its peers like BHP Billiton and Vale continue to ramp up production at their low-cost assets across the globe, exacerbating the market imbalance and pushing prices still lower.

With no clear indication over when commodity prices are likely to hit bottom — iron ore prices slid to another five-year trough just this week — Rio Tinto could see both earnings and dividends disappoint next year and potentially beyond.

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Royston Wild has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.