The City certainly sees reason to believe now is the time to buy Rio Tinto (LSE: RIO). Shares of the iron miner are up 30% from January lows as global production begins to peak and Chinese demand ticks upwards. Analysts are also enthusiastic about improvements to the company’s balance sheet. Net debt may be $13.8bn, but this is a significant improvement on the $22.1bn owed in the middle of 2013. And the company’s gearing ratio (total debt/total capital) is a respectable 24%, much better than the sector at large.
Rio’s balance sheet should continue to improve over the next year as the company’s very low-cost-of-production iron continues to be profitable even at today’s depressed prices. Furthermore, while income investors hated it, the end of progressive dividend payments was a wise move that will save some $4bn this year alone. Shareholders will now receive 40% to 60% of underlying earnings as dividends, which analysts believe will still net a 5.7% yield this year and a 4.9% yield in 2017.
During the Commodities Supercycle Rio branched out into producing other minerals to a lesser degree than competitors did. Now that prices for everything from copper to zinc have fallen precipitously, Rio doesn’t have to waste time selling off non-core assets at a loss and can concentrate on improving efficiency at its core iron mines.
The bad news is that due to the recent rally in share prices, Rio’s valuation isn’t looking as cheap as it was just a few weeks ago. Shares are currently priced at 15.7 times 2017 forecast earnings. This may not be a bargain price, but I believe Rio is still the best option for long-term investors seeking exposure to the commodities sector. The company’s low-cost assets, relatively healthy balance sheet and positive signs from iron prices could contribute to significant share price appreciation in the next few years.
Wait and see
Chilean copper miner Antofagasta (LSE: ANTO) has yet to report 2015 results, but analysts are unsurprisingly pencilling-in a dramatic decrease in income for the year. Although the consensus estimate is for an 84% fall in profits, this still means the company will have a small pre-tax profit for the year. This relative resilience in the face of the commodities crash is, like Rio Tinto, due to a relative lack of diversification.
Antofagasta still brings in the vast majority of its revenue from copper, which has enabled the company to focus on keeping costs low. A relatively strong balance sheet has allowed the company to go out and make cheap acquisitions. While these acquisitions will increase gearing from its current 22%, investors should be cheering Antofagasta for adding significant low-cost assets to its reserves at bargain prices.
Although the shares are down 30% over the past year, the company remains relatively richly valued. Shares are currently trading at 26 times 2017 forecast earnings, suggesting significant growth is already baked-into prices. Antofagasta’s underlying business is very strong and shares have significant upside once copper prices rebound, but at this pricey valuation I would wait for 2015 results to be announced before diving-in.
