Mining for a Rebound

02/09/2009 12:01 am EST

Focus: GLOBAL

Nick Lanyi

Editor, High-Yield International

Nick Lanyi, editor of High-Yield International, thinks the likely commodity rebound will shore up a prominent mining company.

I recently wrote that I think commodity prices will rebound in 2009. As they do, high-yielding Rio Tinto (NYSE: RTP) should be a prime beneficiary.

One of the world's leading mining companies, UK-based Rio Tinto produces gold, copper, iron ore, coal, diamonds, and a variety of industrial metals, such as bauxite, borates, salt, alumina, and primary aluminum. Rio Tinto's gold/copper mines contribute roughly a quarter of its revenue. Its iron ore mines do the same.

The company's products are sent all around the world. Its profits are based on demand for metals of all kinds, as well as its production costs—which are among the lowest in the business, particularly in iron ore and copper.

Rio Tinto and other large miners have engaged in a consolidation drive over the past several years, lowering costs through scale. Fellow giant BHP Billiton (NYSE: BHP) spent a year in talks to acquire Rio Tinto, but pulled out of the deal in late November, causing Rio's share price to collapse.

Meanwhile, commodity prices have begun to rebound from their November lows, but they've got a long way to go—and so does the beaten-down share price of this well-managed mining leader. I think the inflationary pressures from the economic stimulus plans being drawn up by the US, Europe, China, and other governments will push gold prices higher over the next two or three years. When economies begin to recover, commodity prices could boom.

In the meantime, Rio Tinto is taking action to help keep its profitability high during the recession. In December, it announced a plan to cut operating costs (including laying off 14,000 workers or contractors), lower capital expenditures by $5 billion in 2009, and reduce debt by $10 billion by the end of the 2009.

The company recently announced it would maintain its quarterly dividend at $1.36 per ADR, giving it a yield [above 5%] at the recent price of $116.

Rio Tinto generates strong cash flow and has about $100 billion worth of assets on its balance sheet. Its cost-cutting regimen should allow the company to maintain its dividend until cash flows pick up again along with commodity prices.

Rio Tinto could remain volatile as investors remain mired in pessimism about the economy and commodity markets. But this stock serves as an excellent play on a rebound in commodity prices, and it has a solid dividend yield.

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