The last few months have been hugely positive for investors in Rio Tinto (LSE: RIO). Shares in the iron ore-focused mining company have risen by 7% since mid-May and have easily outperformed the FTSE 100, which is down 0.5% over the same time period. Furthermore, Rio Tinto has released upbeat first-half results that show the company is starting to grow its bottom line after a number of challenging years. However, there could be more to come and Rio Tinto could be worth 4190p. Here’s why…
A Changing Landscape
In recent years, demand for commodities such as iron ore has weakened considerably in emerging markets. Certainly, China is a notable example and a slowdown in its growth rate has hit commodity prices hard. This has meant that mining stocks such as Rio Tinto have experienced considerable falls in profits, with Rio Tinto seeing its earnings fall by 38% in 2012 for example.
However, 2013 was a much better year for the company as profit rose by 10% and, while this year may not be quite as strong as last year was, 2015 is all set to be another year of strong growth. Furthermore, the long term looks bright for the company, as an improving global economic outlook should mean that demand for commodities stabilises somewhat, with other emerging economies such as India and China still having vast scope to develop their economies. So, while there has been disappointment in the recent past, the future could be a lot brighter for Rio Tinto simply due to potentially more favourable trading conditions.
A Low Valuation
Despite Rio Tinto being forecast to increase its bottom line by 8% next year, shares in the company continue to offer good value for money. For example, they trade on a price to earnings (P/E) ratio of just 11. This is considerably below the FTSE 100’s P/E of 13.7. In addition, Rio Tinto currently yields an impressive 3.7% despite only paying out 40% of profits as a dividend.
Certainly, the company needs to reinvest in new plant and machinery, but it appears to have the scope to pay out a figure closer to 50% of profit as a dividend so as to provide greater income benefits to shareholders but also maintain a satisfactory level of reinvestment. Indeed, the company appears to be keen to reward shareholders to a greater degree moving forward, as dividends per share are expected to increase by 7.5% next year.
Were it to pay out 50% of profits as a dividend and still trade on the same yield as at present (i.e. 3.7%), it would mean that shares trade at a price of 4190p. This is 22.4% higher than the current share price of 3425p and appears to be a very realistic price target, since shares in Rio Tinto last reached this level as recently as three years ago.
Clearly, there may be a few lumps and bumps along the road ahead, but Rio Tinto appears to have a bright future and, perhaps more importantly, appears to offer top notch value for money at current price levels.
