When I think of global mining company Rio Tinto (LSE: RIO) (NYSE: RIO. US), two factors jump out at me as the firm’s greatest strengths and top the list of what makes the company attractive as an investment proposition.
1) Turnaround potential
Rio Tinto’s financial performance crashed to earth with a bump when the high commodity prices of recent years started to fall. When the firm’s end-product prices were high, demand in the industry for things such as labour, transport and machinery pushed the prices of those things up, which raised Rio’s input prices. That didn’t show up as a big problem when the cash was rolling in, but when commodity prices began to fall and the inflowing cash eased up, the firm’s still-high input costs and falling revenue caused a profits-squeeze.
There’s not much Rio can do about the cyclicality of the resources industry, which causes commodity prices to rise and fall as they please. However, the firm has been tackling its costs and the culture within the organisation, and driving up production levels, under new, highly incentivised, top management. Last month’s full-year results are encouraging. There was a 10% increase in underlying earnings, which seems like things are heading back in the right direction. However, we need to view that result within the context of a longer-term picture. This is how adjusted earnings look over five years:
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| Year to December | 2009 | 2010 | 2011 | 2012 | 2013 |
|---|---|---|---|---|---|
| Adjusted earnings per share (cents) | 357 | 713 | 808 | 501 | 553 |
So, although the uplift is welcome, it is still well down from the peak achieved in 2011. Going forward, investors will likely be looking for more efficiency and production gains and hoping for stable commodity prices.
2) Stable net debt
One year’s profit result is scant evidence to go on. Indeed, at half time last year earnings were down, so we can’t get complacent. Earnings can fluctuate and that’s why it’s a good idea to look at how Rio is building the value of its balance sheet. There was positive news on debt reduction recently, so let’s see how that fits into the wider picture:
| Year to December | 2009 | 2010 | 2011 | 2012 | 2013 |
|---|---|---|---|---|---|
| Net debt ($) | 18,769 | 6,161 | 12,134 | 19,769 | 18,335 |
The reduction in net debt this year is welcome, but the reality is that we are more or less at the same level as that achieved in 2009. So, rather than describing the wider trend as ‘falling’, it’s probably best to describe debt-levels as ‘stable’.
When Rio manages to use its cash flow to drive net debt down to the levels seen in 2010, we’ll know that the firm is making solid progress beyond its last cyclical peak, in my view.
What now?
To demonstrate their confidence, the directors recently hiked the dividend by 15% and new investors will enjoy a forward yield predicted to be around 3.6% at current share-price levels.
