Rio Tinto (RIO), one of the largest mining companies in the world, saw a sharp increase in its share price as iron ore prices increased from $115 to $145 in December 2012. Rio Tinto's CEO Sam Walsh quickly told investors that the price increase was due to short-term factors like the cyclone season and restocking, and that the prices will eventually be corrected in the coming weeks. Below, I will assess the implications of short-term fluctuations of iron ore prices on Rio Tinto's net revenue.
Iron Ore Price Fluctuations and Causes
Though Rio Tinto deals with uranium, copper, aluminum and diamonds, 70% of its revenues come from iron ore. The driver behind this increased price of iron ore is due to mounting confidence that China will buy a lot of iron ore to meet the demands of its burgeoning construction industry. Also, analysts believe that China will import a record amount of iron ore in 2013. Several iron ore mines in the states of Karnataka and Goa were shut down in India by that country's Supreme Court under fears of pollution. These factors and shipping difficulties are due to climatic events such as cyclones in Asia, which contributed to a sharp increase in the price of iron ore.
How Will It Affect Rio Tinto?
Once shipping resumes to normalcy, iron ore demand will be met and the price will return to normalcy. What we are seeing now is a short-term spike, which will not have an effect on Rio Tinto's long-term value. As much as investors would like to believe, this drastic increase of almost $30 in iron ore price will not have any effect on Rio Tinto's dividends and payouts. However, Rio Tinto is in a very strong position because of its iron ore production and naturally existing demand for iron ore. Though the price spike will return to normalcy, the demands shall remain and will continue to help Rio Tinto remain stable and profitable in the coming years. China and India are witnessing a record amount of construction related activity, for which steel is required. Both the countries depend heavily on iron ore to feed their gargantuan growth.
Comparing Rio Tinto with Vale
Rio Tinto is most comparable to Vale (VALE). Rio Tinto has always sought to diversify. It has a huge copper mining project in Mongolia, which recently took off after a lengthy fiasco with local administrators. Its biggest competitor Vale is wholly concentrating on iron ore. It is dependent on iron ore prices more than Rio Tinto is, and any short-term fluctuations will likely affect Vale more than Rio Tinto. At the same time, short-term commodity price fluctuations will not have a positive or a negative effect on a company's long-term revenues. Rio Tinto is safer than Vale, which is wholly invested in iron ore mining at the moment, after divesting its other interests.
Competitors Are Selling Their Iron Ore Mines
Anglo American (AAL) sold its 70% stake in the Amapa iroe ore operation in Brazil. The company has divested non-core assets since 2009, and made almost $5 billion from such sales. Zamin Ferrous, which bought the Amapa iron ore operation, is said to have spent $800 million on it. BHP Billiton (BHP) has been on a divesting spree much like Anglo American. BHP has sold many of its assets to focus on core operations. It recently sold its stake in Mount Nimba, Guinea. BHP picked B&A Mineração as the preferred bidder for the sale. The deal is worth almost $600 million. Teck Resources (TCK) announced that it will spend $1.5 billion in 2013, but chief executive Don Lindsay said that the company is not looking at spending any of that money on iron ore extraction. The company is not currently looking at iron ore as one of its focus areas.
This leaves Rio Tinto as the major player alongside Vale when it comes to iron ore mining. Thanks to diversification and mining for other commodities, Rio Tinto will be able to offset spikes and lows in commodity prices and maintain steady revenue growth. Rio Tinto currently trades at $58 and has a market cap of $108 billion. With the price to sales and price to book ratio of 2, it is performing well alongside Vale, which has similar price to sales and price to book ratio numbers, hovering around the 2 mark. With a profit margin of 7.26% and an operating margin of 32%, Rio Tinto is one of the most profitable mining companies around.