Why I Am Not Buying Rio Tinto Anymore

| About: Rio Tinto (RIO)
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Summary

Rio Tinto has suffered setbacks due to the falling demand for metal from China.

Long-term investors are often not worried by such short-term setbacks.

However, what worries us more is the slashing of Rio’s progressive dividend policy, which indicates deeper issues with the company.

Rio Tinto (NYSE:RIO) is a giant British mining company with operations in Australia, the US, Chile, and elsewhere, with a 100-year-old history, and known for mining (and refining) operations involving iron-ore, aluminium, copper, uranium, coal, industrial minerals, and diamonds. In recent years, Rio has seen takeover bids worth $147 billion from competitor BHP Billiton (NYSE:BHP), which it rejected. It has also seen steady infusion of Chinese funds into the company, with the Chinese state-owned Chinalco now owning a majority stake in the company as an outside investor.

For us Britishers, Rio Tinto stock is like family heirloom. Like an old Victorian timepiece or a first edition Conan Doyle, you put those papers in the bank and forget about them. Like most Rio investors, I have owned RIO stock for decades, only to be reminded about them when the thick, buff envelope came once a year announcing dividends.

However, I am giving up on Rio. I won't sell what I have, but I won't be buying any new shares either. I am giving up on Rio because investors can ignore everything about old blue chip stocks like RIO except when they cut dividends. We can even ignore a $13.8bn debt and an almost $1bn loss last year, but when companies touch our dividend payouts, most risk-averse investors feel the pain.

Just last month, Moody's downgraded Rio from A3 to Baa1, citing poor demand for commodities like iron-ore and excess supplies, which will slow down growth for several years. "There has been a fundamental downward shift in the mining sector with the downturn being deeper and prospects for a recovery extended, resulting in increased credit risk and weaker metrics for Rio Tinto as well as the global mining sector," Moody's said. The strong US dollar has also been held responsible for the ratings downgrade, mainly because it is reducing demand and lowering prices, as the dollar is the global currency for metals trading.

The commodities market, which had enjoyed a decade-long boom, fell as a result of weak demand from China, the world's largest consumer of metal. Although the Chinese national banks tried to infuse new funds into the market to try to stem the tide, that didn't help matters as demand for metal continued to fall. This led to a huge shed-off in value for mining giants like Rio Tinto and BHP Billiton.

It is true that iron-ore prices have seen an upswing this year, and Rio has seen some short-term gains as a result. However, Chinese iron-ore imports have fallen 10% y-o-y in February. Moreover, although the People's Bank of China has assured investors of adding further stimulus to the market, such assurances and indeed, such stimulus itself has historically failed to drive long-term growth in the face of a falling demand for commodities. It seems to this lay investor, at least, that the Chinese market is attaining maturity, and with it, the immediate prospects of many mining companies are going to be stunted.

In recent months, Rio has been cutting down on labour and selling off assets in order to stop the loss of value. Recently, Rio announced in Australia that it would cut 170 jobs in its Pilbarra operations, another 300 at its Perth office, and overall 700 jobs in Australia, in order to reduce operational burden by $1 billion. Pilbarra is/was the most lucrative of all of Rio's mines, a development that took place under Rio CEO Sam Walsh. Indeed, Walsh reduced his own pay from $10.4 million in 2014 to $9.1 million in 2015, a 12.4% reduction reflecting Rio's own larger loss that year.

Rio has also been on the news for layoffs in the USA. Recently, its Kennecott mining operations in Utah saw a layoff of approximately 200 people out of a total workforce of 1620. This is a direct result of falling copper demand in Chinese markets. Kennecott's Bingham Canyon Mine is one of the top producing copper mines in the world.

However, these defensive measures are not going down well with investors; as a result, market capitalisation is falling.

Finally, Rio broke its long-held pledge to investors of a progressive dividend policy when it slashed its dividend payout this year. Rio has announced that future dividend payouts will be tied to profit, and since profit is a sinking quantity these days at Rio, that means a consequent fall in payout ratios as well. This is the worst payout ratio in over a decade, and this hasn't gone down well with investors. Many mining-oriented funds are also divesting from these stocks, looking for greener pastures elsewhere. What with the long drawn-out commodities downturn, the ensuing value loss, and finally, this dividend cut, many investors like me feel that this is the end of the road for us and Rio.

Disclosure: I/we 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.