2011 was an interesting year for mining giant Rio Tinto (RIO), and the carry-over effects from last year could put a damper on 2012 results. For investors, the current year has a high probability of disappointing results. Those with a long-term - 3 years or longer - view should be looking for an entry point when the news looks the worst, and the share price has been beaten down.
Rio Tinto is a global mining company which divides its operations into five mining divisions: Iron ore, Coal, Aluminum, Copper, and Diamonds & Minerals. The company is best known as the second largest iron ore producer in the world.
In 2007, Rio purchased Canadian aluminum producer Alcan for $44 billion, making the company one of the largest aluminum producers. The purchase was at the peak of the commodity boom, and the investment has not yet worked out well for Rio. In 2011, the company wrote off $8.9 billion of the Alcan purchase price. Due to the problems with the aluminum division, the Rio Tinto top executives would not accept any bonus payments for 2011.
Rio Tinto's revenues and profits are highly dependent on the market prices for the minerals and metal ores the company produces. Here are some of the headwinds facing the company in the short term:
- Although average commodity prices were higher in 2011 than in 2010, those prices declined in the second half of 2011. According to data from Rio Tinto management, prices ended the year about 25% lower than at the start of 2011.
- Wages and other expenses are growing faster than revenues. Labor costs, equipment and supplies, and fuel costs are all increasing significantly as mining companies like Rio Tinto attempt to increase their production levels.
- Economic stagnation in Europe and a slowing of economic growth in China are expected to reduce ore demand growth in 2012.
- In 2011, Rio Tinto lost money on aluminum/bauxite operations outside of China.
- Strong currencies from the commodity countries, in this case Australia, hurt bottom line results.
As a result, the Wall Street consensus revenue estimate for Rio Tinto in 2012 is a decline of about 4%. According the adr.com data, the average earnings estimate for the year is $7.55 per share, down from $8.09 earned in 2011. Yahoo Finance lists the 2012 consensus estimate at $8.86 per share for 2012.
There is quite a spread in earnings estimates, but it is difficult to see how earnings could be higher if revenue is expected to decline. The Yahoo Finance numbers are sometimes quite inaccurate for foreign companies trading on the U.S. exchanges. Looking at the earnings estimates from adr.com for the other large mining companies, mean forecast 2012 earnings for BHP Billiton (BHP) are $7.33 per share, down from $8.75 earned in 2011. The average 2012 earnings estimate for Vale (VALE) is $3.65, down from $4.34 per ADR share.
When looking at all of the expectations for economic factors, sales and earnings, there are not many reasons to look for a higher Rio Tinto share price in 2012. For the longer term, the following factors make the company a much more attractive investment prospect:
Global economic growth, with a combination of recovery for Europe and the U.S., and strong growth in emerging market countries, will lead to a steadily increasing demand for iron and other metal ores. The growth will have its ups and downs, but will occur.
Actual iron ore production increases will fall short of projections, resulting in less supply-based pricing pressure. Rio Tinto notes in its presentations that 600 million tons of production increases were forecast for 2008 through 2010. Only 200 tons of that production actually materialized. Of the 800 million tons of new production forecast for 2011 through 2013, less than 100 million had been developed by the end of 2011.
Rio Tinto owns very attractive bauxite and aluminum operations, which will add significantly to the bottom line once the company completes the second phase of the division's transformation. Watch for increasing gross profit results from aluminum.
With a large and growing iron mining operation in Australia, the company is in a prime location to provide ore to the biggest market - China. Expansion of Australian capacities will lead to significant revenue and profit growth.
Investors should keep an eye on the Rio Tinto share price for any declines that would present a buying opportunity. It is very probable there will be a couple of bad news earnings reports which will knock down the share price. Pick up shares then, and hold for three to five years for best growth potential.
A well managed company with strong cash flow, and products which are extremely important to global growth, make Rio Tinto an attractive long-term investment.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.