Listed in both Australia and UK, Rio Tinto (NYSE:RIO) is the second biggest mining company in the world. The diversified metals and miners company has operations across the globe and its main products include iron ore, copper, coal, aluminum, Diamonds & Minerals, and titanium dioxide feedstocks.
Rio Tinto is trading at very attractive valuations. The stock is up by more than 16% in the last three months and has outperformed Vale SA (NYSE:VALE), BHP Billiton (NYSE:BHP), and S&P 500 which are up by 12.5%, 10%, and 3.0% respectively during the same period. The recent management changes along with substantial impairments should result in long-term positives for the company. The company has also improved its balance sheet substantially over the years and offers a high dividend yield of 3.4%. Iron ore represents more than two-third of the company's earnings and a strong rebound in the steel making raw material's price in the last one year has helped RIO post strong results. Despite of many observers predicting prices to crash in August, September, and October as it did in the last two tears, iron ore prices refuse to show any sign of slump.
''I know there is a lot of talk about seasonality but it seems to us that most of the iron ore price volatility has been driven by destocking and restocking cycles rather than any great seasonal effects,'' said Neville Power, CEO of Fortescue Metals Group (OTCQX:FSUMF), the fourth largest iron ore producer in the world.
We don't see any major changes to the position that has been there for a while. The iron ore stocks are still relatively low historically, and there isn't a large amount of room available for destocking. ''That's not to say there can't be some short-term volatility but we don't see any conditions that would support a low iron ore price and certainly not for any period of time. Certainly not to the levels that some of the outliers are talking about.
As mentioned earlier iron ore represents more than two-third of RIO's earnings and the company continues to benefit from strength in iron ore prices. The UK based mining giant reported strong production numbers across the company earlier this month. The most important product group, iron ore, posted a record production in 3Q13. In line with market expectations, production increased 3% Q/Q and 2% Y/Y to 68.3 million ton as company's Pilbara expansion (290 million tons per annum) started in August. Shipments on the other hand increased 11% Q/Q and 4% Y/Y to 68.0 million tons. The total 2013 production guidance of 265 million tons remains unchanged. With project 290 now completed, the company has ability to ship much more than production in coming quarters.
The Pilbara expansion projects 290 and 360 are both better than plan. The 290mtpa is 4 months ahead of the plan with first shipment in Late August 2013. Full capacity is expected by May 2014. The project not only delivered ahead of the original schedule, it is also $0.4 billion under budget. Expansion of the port, rail and power infrastructure to 360mtpa is also on track. The company is seriously considering alternative scenarios to fill up the transport capacity for 360 with volumes from capacity creep at existing mines (10 million tons) or brown field expansions (at least 15 million tons) and delay the construction of large greenfield mines. That would potentially reduce the risk of overcapacity in the market in the near term.
Although there is no change to the groups capex guidance of $14 billion in 2013, the exploration and evaluation spend will drop more than $750 million in 2013. Given the market conditions the drop in the exploration and evaluation spend is encouraging; however, it can be switched on quickly again and if done well should actually create value by discovering new deposits.
Valuation & Financials
The company is trading at attractive valuations. It has a forward P/E of 8.9 and a PEG ratio of 2.0. It has a price/book ratio of 2.1, in line with industry average of 2.1 and slightly below company's own 5 year average of 2.2. It has a price/sales ratio of 1.9, slightly above industry average and RIO's own 5 year average of 1.8. The diversified miner has a price/cash flow ratio of 5.3, lower than the industry average of 9.3 and company's own 3 year average of 6.4.
Commenting on RIO's current valuation, Peter Esho, chief market analyst at Invast, said "Rio is currently trading on around 11 times next year's consensus earnings numbers; there is large scope for upside in these earnings estimates, which have already factored in some turnaround, but not the full extent."
The company has improved its balance sheet significantly over the years. It improved its debt to total capital ratio from 66% in 2008 to 32% in 2013E. Debt to equity ratio is also improved substantially over the same period (From 193% in 2008 to 48% in 2013E). Similarly interest coverage ratio improved from 14x in 2008 to 59x in 2013E. RIO also has a high dividend yield of 3.4%. In comparison BHP and Vale has dividend yields of 3.4% and 5.4% respectively.
We have a buy rating on RIO. After a slowdown of 2 quarters, economic growth in the RIO's biggest customer, China, is showing signs of improvement. Both iron ore and copper are two very important product groups for Rio Tinto, iron ore in particular. While copper imports of the second biggest economy in the world rose to 18 months high, Australia on the other hand raised its price estimates of iron ore on strong buying from steel mills in the China.
Although going forward we have a cautious view of iron ore prices, as the iron ore market transits from its current state of seaborne balance to its future state of excess supply, the strong iron ore price rebound from less than $90 per ton in 3Q12 to more than $150 per ton has been very helpful for Rio as iron ore represents more than two-third of company's earnings. Iron ore prices increased 12% in the third quarter and averaged $133 per ton as compared to $112 per ton during the same period last year. The strong results build further confidence in RIO and show that the company is in control of its operations and costs. The company is looking to cut $5.0 billion in costs by end of next year.
Finally, as stated earlier the mining giant is also trading at very attractive valuations and has a good dividend yield of 3.4%.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.