Shares in mining giant Rio Tinto (LSE: RIO) (NYSE: RIO.US) have oscillated wildly in 2013 — the stock strode to peaks of 3,757p in February, before shedding almost 30% in the space of a few months to hit their cheapest in almost four years as macroeconomic worries again hit investor sentiment.
The stock is currently down more than 10% since the start of the year, and I believe that an environment of worsening fundamentals in its key markets is set to drive the firm’s share price lower from next year and beyond as earnings crumble.
Earnings outlook hardly cast iron
In my opinion, Rio Tinto faces a confluence of price pressures as insipid demand weighs on commodity prices, particularly in the critical iron ore market. As Investec notes, the steel-making ingredient is now responsible for around 99% of the firm’s underlying earnings, surging from just 36% five years ago, partly as contribution from other divisions has nosedived.
Worryingly, the broker advises that “while iron ore [will] still deliver earnings growth, this is expected to be modest as the company’s planned increase in production volumes is offset by our forecast fall in iron ore prices.” The broker expects excess supply in the iron ore market to weigh heavily on prices from 2014, and anticipates the average iron ore price to clock in at $122.5 per tonne next year versus $133 in 2013.
And the commodity is expected to continue sliding in coming years, with prices of $117.5 and $112.5 pencilled in for 2015 and 2016. In my opinion, a backdrop of increasing pressure on Rio Tinto’s key market, not to mention sustained weakness in other key markets such as aluminium and coal, severely undermines the company’s current earnings projections.
Following an expected 1% decline in earnings per share this year, to 306p, the City’s brokers anticipate a sharp 15% snapback in 2014 to 352p.
This expected recovery leaves Rio Tinto dealing on, at face value at least, more than reasonable P/E ratings of 8.8, comfortably underneath the value threshold of 10. And a price to earnings to growth (PEG) readout of 0.6 underlines the company’s appearance as an exceptional bang-for-your-buck stock — any reading below 1 is considered stunning value relative to its growth prospects.
Elevated risks could smash earnings outlook
Still, in my opinion the risks facing Rio Tinto over the next 12 months greatly outweigh the potential rewards, and I believe that the miner is in great jeopardy of severe earnings weakness in coming years. With the global economy remaining in a severely fragile state — as illustrated by recent OECD growth downgrades recently — I believe that the possibility of worsening demand could shatter earnings forecasts for 2014, a situation worsened by a swathe of new mining capacity hitting the market.
