A Brazilian Beneficiary of Asia's Boom

03/21/2007 12:00 am EST


Robert Hsu

Editor, China Strategy and Asia Edge

Ticker symbol RIO

Robert Hsu, editor of Asia Edge, says a giant Brazilian mining company is a good way to play China's insatiable demand for nickel and iron ore, as well as the late stages of the commodities bull market.

Asia's insatiable demand for natural resources has fueled a worldwide boom in commodities. But the commodities bull market is showing its age. In most cases, the easy profits have already been made.

[But] Brazil's Companhia Vale do Rio Doce (NYSE: RIO) is one of the most attractive because it's a leader in two of the hottest commodities right now: nickel and iron ore.

RIO is the world's second-largest metals and mining company, just after BHP Billiton. It has grown enormously from a market capitalization of just $9.2 billion (at the end of 2001) to its current market cap of $82 billion-averaging impressive growth per year of 43%!

What I like [especially] is its increasing exposure to nickel and iron ore, two commodities whose prices are booming.

Nickel's biggest use at the moment is producing stainless and alloy steels. Chinese steelmakers are behind the surge, as China's usage of nickel grew from 15.5% of the world's total consumption in 2005 to 18% last year.

[Meanwhile], the price of nickel has tripled from $15,000 per ton to more than $45,000 in the past four years. Higher nickel prices are here to stay, and I expect RIO to be the biggest beneficiary [because last] October it bought a controlling stake in the leading Canadian nickel company, Inco, [making it] the world's second-largest nickel producer.

Another one of RIO's strongest business segments is iron ore. Here again, China is playing an increasingly important role. Chinese iron ore imports reached 326.4 million tons in 2006, more than tripling from less than 100 million tons in 2002.

Despite steady production growth, China has been unable to keep up with increasing demand. This is a big opportunity for RIO, [whose] iron ore sales to China surged by a staggering 379% over the last five years.

Higher-than-expected demand, especially from Chinese steelmakers, is keeping global iron ore supplies tight [and] demand should stay strong for some time to come. In addition, booming construction in the Middle East is also driving up iron ore demand.

RIO is also a well-managed company. Its return on invested capital remains above 50%. Earnings grew six fold in just four years, [while] profit margin almost doubled from 24.7% to 43.7%. Over the last five years, total shareholder return (capital gains plus dividends) averaged over 50% per year.  [Yet it] is still trading at a trailing P/E ratio of only 13x trailing earnings. And based on this year's projected earnings, its forward P/E is under 9x.

Take advantage of the recent pullback and buy RIO while you can still get it under $36. I'm targeting a conservative $45 in the next three to six months, which would give us a nice short-term gain of about 30%.

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