By: Clarence Darrow, AIM student at
Marquette University (As of 2/1/2018)
Disclosure: The AIM Equity
Fund currently holds this position. This article was written by myself, and it
expresses my own opinions. I am not receiving compensation for it and I have no
business relationship with any company whose stock is mentioned in this
article.
Summary
•
Rio Tinto Plc, Inc. (NYSE:RIO) is
engaged in the business of exploring, mining, and processing of mineral resources.
It is one of the largest and most cost-effective producers of iron ore,
aluminum, copper, coal, diamonds, gold, and other industrial minerals. It
distributes its commodities to many different countries and some of their
biggest customers are China, Great Britain, Hong Kong, Norway, and Canada.
• The company's
iron ore assets in Western Australia are some of the lowest-cost assets in the
iron ore industry and given the proximity to China, provide a tremendous
advantage.
• Any slowdown in
Chinese steel production could weaken iron ore demand
• Current strong
growth due to an increase in iron ore production levels of 360MM mtpa.
• The company
maintains increased exposure to aluminum relative to other miners. If aluminum
prices remain weak it could prove difficult to sell Pacific Aluminum assets at
reasonable price.
• Environmental
laws becoming stricter, restricting mine development or even mine closures
• Currency exchange
rate fluctuations, have a profound effect on the prices of commodities and affect
financial results due to the geographical diversity of the miners’ operations
and sales.
• In the past year
Rio Tinto has reduced debt from 25.37 million dollars to 15.85 million.
Key points: Rio
Tinto is an interesting stock. With their current CFO and Chairperson ready to
step down. This leads to increased uncertainty. Why are both leaving at the
same time? The stock price is also the highest it has ever been. In addition, the company’s performance is
exposed to movements in commodity prices, which makes this a highly cyclical
business. The company has capitalized on the strength in commodity prices seen
in 2016 by improving its balance sheet and reducing its cost structure. The
company has achieved roughly $2.1 billion of cost savings since the start of
last year. It has managed to gradually reduce cash costs at its core iron ore
production business from more than $22 per ton in 2013 to $13.80 per ton in
2017. This has made Rio Tinto one of the lowest cost operators that can
continue generating strong levels of earnings and cash flows in a weak
commodity price environment, which partly mitigates the commodity price risks.
The biggest risk
is the global economy as demand for metals and minerals is highly correlated to
economic growth. China is the world’s largest consumer of aluminum, coal,
copper, iron ore, nickel, and steel. A material slowing in China’s economic
growth trajectory could result in lower prices for commodities. May suppress
global prices.
RIO is expected to
continue seeking ways to reduce expense for its mining operations and closing
any unprofitable branches while continuing the track it has been on. RIO’s cost
effective ways have led RIO to being one of the top market performers but given
the weak commodity price environment they will need to continue looking for
ways to be more cost effective. This could lead to a reduction in stock price
if they are not proactive.
What has the stock done
lately?
The
commodities market is notorious for boom and bust cycles and has been on the
upswing since February 2016, Rio Tinto’s stock is up ~4.5% in the last month.
That is a solid rate of growth, and RIO has increased from $45 a share to $56.07
a share in the last six months. RIO has recently reached its 52-week high of
57.78 and is currently at 56.07. Has this stock already reached its height? Hopefully
the boom cycle will continue.
Past Year Performance: RIO has increased ~31.85% in value over the
past year, but the stock may have reached its potential as it has reached its 52-week
high recently at a high of $57.78. Though it pays high dividends and has
reduced much of its debt expense in the past year and is one has one of the
best capital structures in the industry. With the recent change in management
and given the history of mining companies, this stock bears monitoring. This
stock seems to be fairly priced, but it is hard to know if the stock has
already reached its potential.
My Takeaway
The
commodity market has been up since February 2016, and RIO has been able to take
advantage. RIO has been able to improve its capital structure as a result as
well as pay dividends. Though this is a highly cyclical company due to the
industry the company is in. Therefore, if any commodity prices drop RIO could
be in trouble. In addition, it is concerning to see the CFO and chairperson
step down. Thus, this is a hard stock to read. RIO appears to be the industry
leader in a weak industry that has happened to have a good run over the last
year. Therefore, this stock has certainly caught my attention. As a result,
this stock may need to be sold shorty depending on how one views commodity
market playing out and if they want to have exposure to the commodity sector.
Even though I’m cautious with this stock it does appear to be the best option
of all the commodity stocks in the industry.
