Mining for Value with Rio Tinto
01/24/2018 5:00 am EST
Entering 2018, mining stocks have the potential for a third year of positive returns. The last time the sector pulled this off was during the go-go years of 2003-2007, notes international expert Yiannis Mostrous, editor of Capitalist Times.
Mining can do it, because the global economy is looking at a year where synchronized growth should be the main theme. The caveat to all this is the significant geopolitical risk around the world. Therefore, investors should favor cyclical sectors, with mining being one of them.
China will, once again, be the pivotal factor regarding commodities this year. Although the view here remains that the Chinese economy won’t experience a hard landing this year, how markets react during the slowdown will affect the performance of mining stocks in the second part of 2018.
When allocating funds into the miners this year, stay with the big diversified companies. Our favorite remains Rio Tinto (RIO). The company is one of the world’s largest mining conglomerates, with major interests in copper, iron ore, coal, aluminum, mineral sands, borax, diamonds and gold. Iron ore contributes 57 percent of earnings.
We expect Chinese end-user steel demand to rise this year despite slowdowns in the real estate and infrastructure sectors. Most probably the growth will be half of last years’ rate at around 1.5 percent. Steel margins remain strong in China and, therefore, high-grade iron ore prices should be supported.
During its latest investor update, Rio Tinto’s management said that it aims to deliver $5 billion productivity gains in the next five years. That should lead to increased return on capital, as well as an offset to cost increases.
Regarding capital expenditure, the company expects $5.5 billion this year and $6 billion in 2019 and 2020. That’s up from $4.5 billion in 2017.
Management efforts to lower debt continues, leading net debt to decline from $10 billion in 2016 to $2 billion in 2017. Gearing may need to increase a little, but it’s not so low that the company has enough room to increase debt while returning cash to stockholders.
During 2017, Rio returned $6.3 billion to shareholders in the form of dividends ($4.2 billion) and share buybacks ($2.1 billion). Expect both to continue, with each increasing during the next two years. With a 3.9 percent dividend yield, Rio Tinto is a buy on pullbacks up to $55.