Are Rio Tinto plc and Next plc a buy after today’s results?

Roland Head asks if income hunters should be buying Rio Tinto plc (LON:RIO) and Next plc (LON:NXT) after today’s updates.

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Shares in high street fashion chain Next (LSE: NXT) rose by more than 3% this morning, after the group reported a 1.8% rise in sales during the six months to 30 July.

The firm’s first quarter trading update in May showed that sales fell by 0.9% during the first quarter, so today’s positive figure was a relief for investors. However, it’s clear that the market is still challenging. Full price sales are down by 0.3% so far this year, due to weaker high street activity.

Discussing the EU referendum, Next said that so far there’s no evidence of a change in consumer behaviour. However, the weaker pound means that the group’s purchasing costs from Asian manufacturers are likely to rise by up to 5% next year.

As usual, Next provided detailed profit guidance for the remainder of the year. Group pre-tax profit is expected to be within a range of £775m-£845m this year. That’s an improvement on May’s guidance of £748m-£852m, as the lower limit is £27m higher than it was at the end of Q1.

Earnings per share are expected to be between 2.5% lower and 6.3% higher than last year. This suggests a range of 430p to 469p per share, which is slightly ahead of analysts’ forecasts of 433p per share.

Based on these figures, Next shares currently trade on a forecast P/E of about 12.5. That seems reasonable value to me, especially as the group is expected to pay total dividends of 203p this year, giving a 3.8% yield. Next remains a buy, in my view.

Mining outlook “volatile”

The new chief executive of Rio Tinto (LSE: RIO), Jean-Sébastien Jacques, said this morning that the mining market remained “uncertain and volatile”.

During the first half of 2016, Rio generated operating cash flow of $3,240m, down by 27% from $4,435m during the same period last year. Underlying earnings per share fell by 45% to $0.87.

However, the group reported a further $600m in sustainable cost savings and generated free cash flow of $2bn. As a result, net debt fell by $800m to $12,904m.

Rio will pay an interim dividend of 45 US cents per share and confirmed plans for a total payout of no less than 110 cents per share for 2016. That’s consistent with City forecasts and equates to a yield of about 3.4%.

As a long-term shareholder in Rio, I’ve grown used to the volatility of the firm’s shares. In my view, the firm’s long-term and low-cost assets make it an excellent income stock. Today’s results show why. Rio’s EBITDA profit margin — earnings before interest, tax, depreciation and amortisation — was 33%. The group’s iron ore division reported an EBITDA margin of 58% and generated $1,332m of free cash flow, despite very low iron ore prices.

Is Rio still a buy?

Rio shares have risen by 17% since the EU referendum. The group’s reporting currency is the US dollar, so the pound’s weakness against the dollar has boosted the value of the firm’s UK-listed stock.

Despite this, I’d argue that at around 2,400p, Rio Tinto shares remain reasonably good value for long-term investors. The group is robustly profitable at current commodity prices and the dividend yield is attractive and should be comfortably covered by earnings.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head owns shares of Rio Tinto. 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.

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