Money Lies Beneath The Surface According to This Mining Company

By Ankit Agrawal - September 17, 2012 | Tickers: BHP, VALE, FCX, RIO | 0 Comments

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If someone wants to make a big profit quick and has good exposure of industries then I suggest them to focus on companies like Rio Tinto (NYSE: RIO) that fluctuate greatly. I specifically like Rio Tinto because of its stock transparency.  Even though, this company is diversified and has huge global exposure, I believe the parameters to judge the stock price movements are relatively less. Thus, one can make huge profits with relatively less cogitating. Before going any further, let me describe about the current position of the Rio’s stock and earnings. This stock has seen a huge downfall of ~22% since the start of the current year. Rio Tinto reported 1H12 underlying EBITDA of $10.08 billion vs. the consensus estimates of $9.87 billion but 29% below the 1H11 EBITDA. Lower commodity prices decreased underlying earnings by $1.94 billion compared with 1H11. The following chart shows the stock price movement of the company:

I believe the recent dip provides an opportunity to invest as I see following events to provide upside to earnings in the near term.

Recovery in Raw Material Prices

Spot prices for steel making raw materials like iron ore and metallurgical coal have declined largely (Fig 1). I believe that continued weakness in construction demand and the over production of crude steel attributed to the collapse in Chinese steel prices and aggressive margin compression which eventually initiated the raw material price declines in the late June. I anticipate prices of these raw materials to recover in 4Q12 after a further fall below the marginal cost to drive out the short-term supply overhang. I also expect Chinese steel mills to complete finished product and raw material destocking to stabilize prices and a stimulus-driven demand recovery to trigger a restocking cycle.

Fig: 1

New Tunnel Boring System to Reduce Development Time

Rio’s has block caving expertise with Northparkes as a leading block cave operation. The company is targeting 7% of its Cu production from block caving in FY12. I believe Rio’s new tunnel boring system will significantly reduce underground development times that could bring UG production forward. The company believes and I agree that this will become a differentiator vs. peers. I expect new tunnel boring system along with Nuwave system (technology that upgrades low grade copper ores) will boost the production rate and thus provide the upside to the earnings.  

Holding in Richards Bay Minerals

Rio Tinto has doubled its holding in Richards Bay Minerals (RBM) following the completion of its acquisition of BHP Billiton's entire interests. The purchase price paid by Rio Tinto on completion was $1.7 billion. I believe this acquisition and doubling of stakes will further strengthen Rio Tinto's titanium dioxide portfolio at a time when the long-term outlook remains robust.

Rio Tinto's competes with diversified international mining firms like Vale S.A. (NYSE: VALE), BHP Billiton (NYSE: BHP) and Freeport McMoRan (NYSE: FCX). The following table summarizes the P/S ratio, P/B ratio and forward PE of Vale, Freeport, Billiton and Rio:

Among these firms only Vale has a lower P/B ratio and a lower forward P/E than Rio Tinto. Otherwise, Rio Tinto currently has the both lowest P/B and P/S ratio among these firms. Therefore, for those investors who are optimistic about strong growth in mining industry as a whole, I suggest Rio as a best choice. Rio Tinto shares tend to track market expectations for its earnings. Rio Tinto's earnings are a function of the price of its main commodities: iron ore, copper, aluminum and coal. I expect doubling of holdings in Richards Bay Minerals, recovery in prices of raw materials and new tunnel boring system to provide potential upside to the earnings. Thus, I recommend buying it.

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