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Are Rio Tinto shares a good investment?

by | Last updated 26 Nov, 2022 | Materials

Rio Tinto Plc (LSE:RIO) shares are down about 2% year-to-date and flat over the past year, that’s roughly in line with the FTSE 100. And considering how tumultuous the stock market has been lately, these shares seem to be holding up quite well.

Does that make them a good investment for my portfolio? Or should I be looking elsewhere for other attractive investment opportunities?

What does Rio Tinto do?

Rio Tinto was founded in 1873. Today it’s a leading global mining and mineral resources company headquartered in London.

The firm engages in the mining and processing of aluminium, iron ore, copper, diamonds, gold, salt, lithium, borates, and titanium dioxide. Its diversified portfolio of mining sites is scattered around the world. It currently has over 50,000 employees operating across 36 countries and six continents. However, its flagship projects predominantly reside in Western Australia and North America.

Rio Tinto shares first debuted on the London Stock Exchange in 1973. The share price has increased in the last decade by around 55%. And in the previous five years, it’s up by 38%. That’s ahead of the FTSE 100’s performance.

The numbers may seem unimpressive. But it’s worth noting that Rio Tinto shares have consistently offered an average dividend yield of around 8% throughout its history. And following the latest surge in commodity prices, today’s yield stands at a whopping 11.3%!

So, seeing this stock be a darling amongst income and institutional investors is hardly surprising. In fact, as of February 2022, over 70% of the shares outstanding are held by investment funds. In my eyes, that speaks volumes of the trust financial institutions have in the future performance of this business.

What does the key financial information say?

Rio Tinto’s fiscal year end on 31 December. And in July earlier this year, the group released its interim results.

Generally, 2022 has been an unprecedented year for most industries. And Rio Tinto shares are no exception. Financially and production-wise, the company’s performance in H1 2022 was below its performance in the same period of 2021 on the back of weakening commodity prices.

Net cash generated from operating activities fell by 23% versus 2021 levels. However, it’s actually up by 80% when compared to 2020 levels. Similarly, free cash flow is also down by 30% year-on-year but up by 154% compared to the first half of 2020.

Net earnings in the last six months came in at $8.9bn – that’s 28% lower than the 2021 first half. And its $15.6bn underlying EBITDA is also down by 26%.

Given these double-digit declines across the board, it may seem strange that Rio Tinto shares haven’t dropped off a cliff. But this performance slowdown wasn’t unexpected since 2021 was an exceptional year for the commodity price of many resources.

To the joy of Rio Tinto shareholders, the company continues to pay a sizable dividend. In fact, in the latest report, management declared an additional $4.3bn is being paid out. That’s the second-highest interim dividend announced in the entire history of the business and equates to a 50% payout ratio.

As of 30 June 2022, the company had net cash of $291m compared to $1.58bn at the end of 2021. This massive reduction stems from the aforementioned dividend payout as well as an $825m acquisition of the Rincon lithium project. 

What risks do Rio Tinto shares have?

No business is without risk. Before investing or buying the shares of any company, I try to understand the various threats it has to face.

The leadership team categories the company’s risk profile into three sections:

  • Operational – Threats to mining and refining activities. Luckily there have been no fatalities in the last three years from accidents.
  • Economic – Fluctuations in macroeconomic factors and commodity prices.
  • Strategic – Acquiring the right talent and investing in new value-building projects.

But there are additional threats on the horizon that Rio Tinto still need to address. The biggest one in my eyes is the push towards net zero emissions.

It’s no secret that mining isn’t good for the environment. And that’s already placing the firm in the crosshairs of activists and new green government policies. Management has laid out plans to invest $7.5bn in green energy and carbon abatement projects between 2022 and 2030. But whether this will be sufficient, only time will tell.

Should I invest £1,000 in Rio Tinto right now?

Mining stocks are a cyclical stock market sector. They go through multi-year periods of growth followed by underwhelming periods of decline in a loop defined by the fluctuations in the commodity markets.

Where we are in the current cycle is anyone’s best guess. While many assume we’re near the peak of the growth cycle, continued demand for investments in renewable technologies could mean the cycle has plenty more to deliver.

Looking at the valuation today, Rio Tinto stock is trading at only five times earnings. That, to me, looks cheap. And when paired with an impressive 11% dividend yield, I can’t help but feel a buying opportunity may have emerged.

It’s possible that the decline of the commodity cycle may have started. And if that’s the case, I could be looking at a value trap here.

But given the continued need for metals like copper, lithium, and iron ore, amongst others, I’m confident Rio Tinto shares can deliver plenty of long-term passive income. That’s why I’m considering adding £1,000 worth of stock to my portfolio today.

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Prosper Ambaka does not own shares in any of the companies mentioned. The Money Cog has no position in any of the companies mentioned. Views expressed on the companies and assets mentioned in this article are those of the writer and therefore may differ from the opinions of analysts in The Money Cog Premium services.

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