Rio Tinto plc or Cobham plc – which is the best investment?

Today I’ll be discussing the outlook for mining giant Rio Tinto (LSE: RIO), and defence group Cobham (LSE: COB). Which of these companies makes a better investment?

Iron awe

Multinational mining corporation Rio Tinto updated the market with a strong set of results recently when it announced production figures for Q1. Rio is the world’s second largest producer of iron ore, and during the first quarter of this year global production was up 13% to 84m tonnes, with global shipments rising by 11% to 80.8m tonnes.

The company also reported increases in bauxite and aluminium production, together with small declines in copper and coal production. The Anglo-Australian miner has seen its shares enjoy a nice rally since the start of the year and is now trading 34% higher than three months ago. Yet at around £23 the shares are worth less than half of their value in 2008 when they reached highs of £58.

Despite the encouraging update, I’m still bearish on Rio, as I find the valuation unappealing. Market consensus points to a 41% fall in earnings this year, followed by a 19% recovery in 2017. This puts the shares on a forward price-to-earnings (P/E) ratio of 23 for this year, falling to 19 next year. Too expensive for me, and still too risky given the uncertain outlook for commodities.

Cobham hits turbulence

Defence firm Cobham has seen its shares fall sharply this week after the company announced its first quarter update. The FTSE 250-listed firm revealed that its trading profit in the first quarter of 2016 was £15m, well below the £50m for the same period last year. The company blamed operational issues in its Wireless business leading to delayed shipments and a subsequent one-off charge of £9m.

The Dorset-based firm also said it would launch a rights issue in the second quarter of this year to raise £500m. Consensus forecasts predict a 4% decline in earnings for the full year, followed by a 6% rebound in 2017. This would put the shares on a forward P/E ratio of 8.2 for this year, falling to just 7.7 for the year ending December 2017.

Dividends are forecast at 11.49p for this year, rising to 12.06p next year, giving prospective yields of 5.4% and 5.7%, respectively. Brave investors might want to pounce on the opportunity to buy the shares on the cheap, with the added bonus of generous dividends. But mere mortals might want to pass.

The verdict

In my opinion, both Rio Tinto and Cobham are high-risk investments. In the case of Rio, the risks are largely due to the uncertain outlook for commodity prices, which lead to unreliable earnings projections. However, investors keen on gaining exposure to the mining sector should certainly take a closer look at Rio, but my advice would be to drip-feed into the stock to smooth out the effects of share price volatility.

Cobham has seen its shares fall by 28% in the last week, and now has a very tempting valuation, with the added bonus of chunky dividends in excess of 5%. On that basis Cobham gets my vote over Rio. However, risk-averse investors should probably wait until after the rights issue later this year, by which time brokers will have further revised their earnings estimates. This should give us a clearer picture of what lies ahead. 

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