Shares in FTSE 100 mining giant Rio Tinto (LSE: RIO) are down 16% from their 26 January 12-month high.
Like many companies in the sector, it has been hit by China’s uncertain economic recovery after three years of Covid.
Since the mid-1990s, the country has posted double-digit or high-single-digit growth that pushed commodities prices higher.
A key risk in Rio Tinto shares, then, is that China fails to recover fully in the coming years. Another is that demand declines elsewhere for an extended period.
In my view, though, the stock looks promising for three key reasons.
China fears appear overdone
China’s economy grew by ‘just’ 5.2% in 2023, rather than bigger numbers seen before Covid. The government’s economic growth forecast for 2024 is again around 5%.
I think this target will be reached but many analysts believe it is likely to be nearer to 4.5%.
However, China’s economy is valued at $18trn, and India’s – currently the darling of the developing commodities markets – at $3trn.
Therefore, even 4.5% annual growth would mean China adding an economy the size of India’s to its own every four years.
Well-positioned business
Rio Tinto looks well positioned to me to benefit both from China’s recovery and the global energy transition.
Its Q4 2023 production update, released on 16 January, showed mined copper production up 5% year on year. Copper is extensively used in China’s infrastructure developments. It also plays a vital role globally as a conduit in renewable power generation.
Aluminium production increased by 8% over the same period. This is widely used in China’s manufacturing of vehicles, electronics, and consumer goods, as well as in construction. It is also globally a crucial component in electric vehicles and the solar energy sector.
The company also remains a key player in the lithium market, essential in rechargeable batteries for cars and electronic devices.
Undervalued against its peers?
On a standard price-to-earnings (P/E) ratio basis, Rio Tinto does not look undervalued. It currently trades at a P/E of 12.9 against a peer group average of 10.8.
However, it does look undervalued on a price-to-book (P/B) ratio basis. It is trading at a P/B of 2.2 compared to its peer group average of 2.4.
This said, both ratios look at previous results. So to ascertain where the valuation may be going, I looked at future earnings estimates.
Consensus analysts’ forecasts are for earnings to increase by 7.2% a year to the end of 2026. Earnings per share are expected to rise by 6.7% a year to that point.
On this forward-looking basis, Rio Tinto looks to offer good value overall at its current price.
High-yield stock
The total dividend in 2022 was £4.07, giving a yield of 7.5% on today’s share price of £54.10.
The FTSE 100’s current average payout is around 3.9%.
I already have holdings in the sector, so buying more stock in would unbalance my portfolio.
If I did not have these holdings, I would be tempted to buy Rio Tinto for the three reasons mentioned above.
