Will Commodities Giant Rio Tinto Plc Prove A Better Investment Than Royal Bank Of Scotland Group Plc?

Are Royal Bank of Scotland Group Plc’s (LON: RBS) problems deep enough to make it a worse option than Rio Tinto Plc (LON: RIO)?

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Although banks in the US long ago moved out from under the shadow of the Financial Crisis, the UK’s largest lenders continue to toil away at cleaning up their balance sheets, raising capital buffers and groping in the dark for a viable business model. And while few in the sector inspire much confidence of great future shareholder returns, Royal Bank of Scotland (LSE: RBS) is certainly in the running for laggard of the industry.

The Edinburgh-based lender notched up its eighth consecutive annual loss in 2015 and compounded this poor news by pushing back a return to dividend payments and lowering short-term expectations. Value investors looking at the bank’s price/book ratio of 0.28 might be tempted to chalk it up as a bargain, but I would remain leery.

The bank will rightly point towards its industry-beating core capital ratio of 15.5% as a sign of safety and strength, but there’s little else to cheer about the underlying business. Retail banking return on equity of 11.4% is nothing to scoff at, but is still worse than Lloyds’ 15% and Barclays’ 12.1%, and is trending in the wrong direction. Net interest margin, the profit the bank pockets on the difference between deposits and loans, also fell year-on-year as competition heated up and interest rates remained low.

Refocusing as a domestic-oriented lender is wise, but shareholders are missing out on all the gains of a strengthening domestic economy while competitors such as Lloyds return to substantial dividend payments. At the end of the day, RBS is struggling to rein-in high costs, lags competitors in key performance metrics, and still has a considerable amount of bad assets to dispose of. All of these are reason enough for me to believe shares won’t bring stellar returns in the years to come.

Riding out low prices

Rallying commodities prices, including last Monday’s record 19% rise in iron ore prices, have sent shares of Rio Tinto (LSE: RIO) surging 25% higher than January lows. This good news should cheer investors more accustomed of late to 25% drops, but it may not be plain sailing for the shares going forward.

Prices for iron ore, Rio’s main commodity, remain reliant on Chinese demand, which has been slowing significantly as that country’s building boom tapers off. However, the lack of diversification at Rio has allowed the company to assiduously cut costs, and iron ore still added nearly $4bn to earnings last year. These low-cost-of-production assets helped keep net losses for 2015 to a relatively low $866m.

Of equal importance to the price of iron is Rio’s balance sheet. Net debt of $13.8bn will scare many, but the company has on hand $9.3bn in cash and its gearing ratio (total assets/total debt) is a very manageable 24%. Slashing dividends by more than half will save roughly $4bn this year, and together with continued cost saving measures will ensure the company is able to ride out a sustained period of low iron prices.

Going forward, Rio’s strong base of low-cost assets and healthy balance sheet lead me to believe it will have no problem outperforming struggling RBS in the coming years. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended Rio Tinto. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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