Many investors who focus on a low price-to-earnings (P/E) ratio and high dividend yield in their search for value will have a hard time swallowing the maxim legendary investor Warren Buffett lives by: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”.
Today, I’m considering whether FTSE 100 miner Rio Tinto (LSE: RIO) (NYSE: RIO.US) is a wonderful company, and whether its shares are trading at a fair price.
Wonderful companies
When we think of the typical Buffett ‘wonderful’ company, we think of global consumer-goods giants with fantastic brands — companies such as Coca-Cola. These businesses have great pricing power, terrific margins and a consistently high return on equity.
Miners — who have high fixed costs and are at the mercy of cyclical demand and volatile commodity prices — are about as far away from the quintessential Buffett business as you can get. You’ll look in vain for a miner among the holdings listed by Buffett’s Berkshire Hathaway investment company.
Stung by miners
Things were different once. In his 1980 letter to Berkshire shareholders, Buffett said that through investments in Kaiser Aluminum and Alcoa, “[w]e have a much larger economic interest in the aluminum business than in practically any of the operating businesses we control”.
However, in his next year’s letter, Buffett told shareholders Berkshire sometimes makes mistakes. He continued with characteristic self-deprecating humour:
“Of course, it is necessary to dig deep into our history to find illustrations of such mistakes — sometimes as deep as two or three months back. For example, last year your Chairman volunteered his expert opinion on the rosy future of the aluminum business. Several minor adjustments to that opinion – now aggregating approximately 180 degrees — have since been required”.
The days of Buffett investing in bauxite miners/aluminium producers and other hole-diggers, such as Cleveland-Cliffs Iron (now Cliffs Natural Resources), are a distant memory. And rumours in recent years that Buffett was about to get back into mining — coal, to supply his Mid-American Energy utilities business, and a bid for a big diversified miner in 2011 — have come to nothing. The big miner in question was Rio Tinto.
Rio not so grand
Funnily enough, Rio Tinto got into big trouble with Buffet’s old bête noire: aluminium. The company paid over the odds to buy Canadian giant Alcan for $38bn during 2007. The assets have since been written down by something of the order of $28bn, and prompted the abrupt departure of chief executive Tom Albanese earlier this year.
Rio Tinto’s new boss, Sam Walsh, has characteristics Buffett likes. Walsh has been with Rio for over 20 years, and says his priorities are disciplined investment and a relentless focus on costs.
But will Buffett ever be interested in miners again? Perhaps the biggest pointer to answering that question is his $44bn mega-acquisition of Burlington Northern Santa Fe railroad during 2010. For a play on the long-term demand for coal, iron, etc., he has ploughed his cash not into miners but into a company that shifts the stuff they produce from A to B.
Rio Tinto, at a recent share price of 2,950p, may be ‘cheap’ on a forecast price-to-earnings ratio of 9.6, but it seems Buffett does not have the miner on his ‘wonderful companies’ list.