Rio Tinto (LSE: RIO) (NYSE: RIO.US) has delivered a 12% gain for investors over the last six months, but still looks cheap to me.
Rio shares currently offers a prospective yield of 3.5%, and trade on a 2014 forecast P/E of 9.2, despite forecast earnings per share growth of 11.5% for this year.
However, although I’m happy to be a Rio shareholder, I’m aware that not all of the company’s assets are of equal quality — indeed, there are some that I’d be quite happy not to own shares in.
The bottom line
Rio bills itself as a multi-commodity miner, and it’s true that the firm is a global player in the iron ore, aluminium, copper, coal and diamond industries.
However, the bottom line is that only one of these commodities pays the bills and funds Rio’s dividend payments — iron ore. This point is made painfully clear by Rio’s latest interim results:
| H1 2013/14 | Revenue | Post-tax profits |
|---|---|---|
| Iron ore | $11.8bn | $4.3bn |
| Aluminium | $5.3bn | $123m |
| Copper | $3.1bn | $348m |
| Energy (coal) | $2.6bn | -$52m |
| Diamonds | $2.0bn | $192m |
Source: Rio Tinto company reports
Rio’s 36% net profit margin on iron ore sales generated $4.3bn in post-tax profits during the first half of this year. In contrast, the combined profits from Rio’s other divisions were just $611m.
This wasn’t a one-off, either. In 2012, Rio’s iron ore profits accounted for 86% of the firm’s net earnings, while in 2011, iron ore provided 80% of profits.
Iron ore vs the rest
Rio’s highly profitable iron ore business effectively underwrites the risk attached to the firm’s less profitable businesses, most of which provide little in the way of benefit to shareholders.
The firm demonstrated this last year, when it reported impairments totalling $14.4bn, after being forced to write down the value of its aluminium business and its Mozambique coal assets, both of which it acquired during the mining boom, and paid too much for.
In fairness, Rio’s copper business has previously been a much more significant contributor to the group’s profits, and I expect it to become increasingly important again over the next few years, as production ramps up at the firm’s giant Oyu Tolgoi mine in Mongolia.
However, I think it’s possible that Rio shareholders would be better served if the firm spun off its aluminium, coal and diamond businesses into a separate entity. Rio shareholders could then benefit directly from the higher margins and growth potential offered by its iron ore and copper businesses, without the risks attached to its coal and aluminium divisions.