The Motley Fool

Are high-risk Lloyds Banking Group plc and Rio Tinto plc worth a punt at current prices?

The number crunchers expect Rio Tinto (LSE: RIO) to experience strong bottom-line growth in 2017, but the prospect of correcting commodity values takes the sheen off the mining goliath in my opinion.

Buoyant Chinese iron ore demand, allied with optimism surrounding President Trump’s infrastructure pledges, has seen prices of the commodity continue their stellar rise in recent months. But a correction is still widely anticipated as Asian warehouses fill up, and producers of the steelmaking component aggressively ramp up their mining activity the world over.

So while the City expects earnings at Rio Tinto to detonate 42% in 2017, a 23% decline is chalked-in for next year as revenues retrace once more.

Credit where credit is due, Rio Tinto’s huge asset-shedding and cost-cutting scheme has exceeded even the most optimistic of expectations, helping supercharge cash flows and take the sting out of the inevitable dividend cut. Indeed, a full-year 170-US-cent-per-share reward for 2016 smashed the company’s earlier warning that the dividend could fall as low as 110 cents.

However, the prospect of a current commodity price bubble, worsened by signs of massive speculative buying activity in Asia, leaves Rio Tinto’s long-term earnings profile on dangerous footing. And I think investors should subsequently give the stock short shrift despite an attractive forward P/E rating of 11.3 times.

Banking bothers

While still below its pre-referendum levels, shares in Lloyds Banking Group (LSE: LLOY) have continued their steady upward march in recent months as economic indicators have remained broadly resilient.

Indeed, Lloyds is now dealing at levels not seen since the immediate aftermath of June’s vote. And why not? After all, brokers continue to hurriedly upscale their pessimistic financials, and the Bank of England itself has again upped its own assumptions in recent days. The institution now expects expansion of 2% in 2017, up from a prior estimate of 1.4% made just three months ago.

But while the economy may not be on the verge of collapsing, this certainly does not mean earnings are set to detonate at domestic-based banks like Lloyds — rather, the latest upgrade by Threadneedle Street, if proved correct, would still represent nothing more than stagnation for the domestic economy.

Besides, the full impact of Brexit is always likely to be felt in the medium-to-long-term, first as government invokes Article 50 — currently scheduled for March — and gets the withdrawal process going. Then when the UK finally extracts itself, we have a situation that could weigh heavily on economic growth in the decades ahead, particularly should a so-called hard Brexit come to fruition.

The City certainly does not believe the bottom line will thrive in the current environment, and expects a 3% fall in 2017 to worsen to a 6% drop in 2018.

Given Lloyds’ lack of foreign exposure to mitigate these troubles, as well as signs that already-crushing PPI penalties are accelerating again, I reckon the firm carries too much risk at present. And a forward P/E ratio of 9.5 times is a reflection of this rather than representing a sage buying opportunity.

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Royston Wild 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.