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Why I Would Stay Away From Rio Tinto plc And Glencore PLC

As a shareholder, I like to know that the management of the company I’m part of is intelligently using shareholder funds. With this in mind, I’m always on the lookout for expensive or ill-fitting acquisitions, excessive management payment packages, or poorly timed stock buybacks.

And two companies that have both unveiled multi-billion dollar stock buyback plans during the past twelve months are Rio Tinto (LSE: RIO) and Glencore (LSE: GLEN). Unfortunately, both of these plans appear to be a waste of money.

Now I’m not against buybacks entirely. Used correctly they can be a tax-effective way to boost shareholder returns. Nevertheless, buybacks only make sense if the company in question has a 1) strong balance sheet; 2) stable earnings; 3) can find no other ways to deploy cash and achieve a higher return.

Rio and Glencore have none of these three traits.

Weak balance sheets 

Glencore has put in place a $1bn stock buyback allowance, while Rio has implemented a $2bn allowance. But even though these are welcome returns to shareholders, the funds could be put to better use elsewhere. 

For example, both companies have faced pressure from analysts regarding their weak balance sheets over the past twelve months.

Glencore has $15bn in gross debt supporting its trading and marketing arm, which is set to provide 45% group profit this year. However, Glencore’s credit rating of BBB is only one level above junk.

A downgrade to junk would seriously impeded the group’s trading and marketing ability. To avoid a downgrade Glencore could be forced to sell assets, cut its dividend or reduce capital spending. With this being the case, a $1bn stock buyback seems to be a waste of shareholder cash. 

Additionally, Rio’s gearing will rise from 19%, to 21% following its $2bn stock buyback. This isn’t huge change. Nonetheless, at a time when the price of iron ore is collapsing and demand for the commodity is stagnating, it would be more prudent to hold  cash for a rainy day, not spend it buying back stock. 

Expansion 

Rio and Glencore could also use cash earmarked for buybacks to buy up struggling peers.

Indeed, many publicly traded mining companies are currently trading at multi-year lows, offering plenty of options for the astute deal maker. Glencore and Rio could be making use of this opportunity to bolt-on some growth at low prices.

This strategy is likely to yield better results over time for shareholders than buying back stock. 

The bottom line

All in all, rather than spending shareholder funds on buybacks both Rio and Glencore should be looking to strengthen their financial positions and make acquisitions.  

That’s why I’m avoiding these two miners and looking elsewhere for deals.

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Rupert Hargreaves 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.