Iron ore prices have been tumbling thanks to a slowdown in demand from China while production is hitting record levels, and that’s been hurting some of the smaller Australian miners which can’t compete on costs with the big operations — and it’s led to a run of short-selling of some stocks.
Why, then, would you want to invest in Rio Tinto (LSE: RIO) (NYSE: RIO.US) right now, when the £45bn miner gets nearly half of its turnover from iron ore and does more than a third of its business in China?
Short-term bears
It’s a long-term versus short-term thing, and at the moment the short-term bears are winning out. The Rio Tinto share price, after a promising run from mid-June, has turned tail and lost nearly 11% in just six weeks. At 3,141p as I write, it’s down 7% over the past 12 months and down 13% since February’s peak.
Where is the price of iron ore going in the next few months? It’s impossible to tell, but commodities analysts are expecting an uptick before the end of the year — and obviously over the longer term, prices are not going to remain at record lows.
A short-term squeeze on the industry can be a good thing, as it will help get rid of some of the less efficient producers, or at least perhaps get them to shift their focus away from iron. What’s left will be a fitter sector, and that is very much in the favour of the big and efficient producers like Rio Tinto.
Share prices depressed
And when a sector is in a downturn and the weaker players are struggling, canny investors can pick up shares in the better operators at bargain prices.
Right now, even with a 6% fall in EPS forecast for the year to December 2014, Rio Tinto shares can be had on a forward P/E ratio of just 10 — and with a 7% EPS recovery penciled in for the following year, that would drop to 9.3.
It’s a cyclical sector, and we should expect a P/E a little lower than the long-term FTSE average of 14, but that just looks too cheap to me. In fact, it’s the lowest that Rio shares have been on since they dipped to a near-criminal multiple of just 6 in 2011.
Dividends are still looking healthy, with yields of 4.1% and 4.4% forecast for this year and next, and that’s significantly ahead of the FTSE average. The cash should be well-enough covered too, by close to two and a half times.
Long-term bargain?
Should you buy Rio Tinto shares, then? You’ll have to do your own research and make your own decision, but if you put the long term ahead of the short term, you might just like what you see.
