Where China goes, mining stocks like Rio Tinto (LSE: RIO) (NYSE: RIO.US) faithfully follow. When the China International Capital Corporation cut its GDP growth forecast from 7.6% to 7.3%, Rio bled. When news broke that Chinese exports had fallen 18%, Rio came tumbling after. But when the news is good, Rio smiles.
Chinese Premier Li Keqiang has just hinted that the Chinese authorities will step in to revive the country’s flagging economy. His suggestion that the government shouldn’t ignore “downward risks” and has the “ability, confidence and conditions to make sure the economy runs within a reasonable range”, instantly raised hopes of another set of stimulus measures. Rio also rose.
Don’t Blame It On Rio
This has been the story of the last decade. Mining stocks went stratospheric on the back of voracious Chinese demand for metals and minerals, then crashed back to earth as China crashed. Rio Tinto’s share price is down almost 25% over the past three years, against modest 2% growth on the FTSE 100. You can blame that on China, rather than any fundamental problem with the stock.
Chief executive Sam Walsh has turned Rio round after predecessor Tom Albanese’s bungled acquisition strategy led to a painful $14.4 billion of write-downs. Rio made a $3.5 billion profit before tax last year, against a $2.34 billion loss in 2012. Walsh rewarded patient investors with a 15% hike in the dividend.
To boost the balance sheet, Rio has also been selling off businesses, paying down debt and slashing capital expenditure. These measures were well-received, but did little to spark the share price. But one set of unsatisfactory figures from China, or a few opaque words from its Premier, and it all kicks off.
China On My Mind
I’ve been surprised to see how bullish analysts remain about Rio and other miners such as BHP Billiton. Yes, the minors have been ramping up production, but they remain heavily exposed to a single, increasingly shaky, customer. Rio is especially exposed, given its relative lack of diversification, and heavy reliance on iron ore. The price is down 18% since the start of the year, largely due to the slowdown in China’s steel industry.
Rio’s dependency on China is defined in the following two figures: China accounts for around 50% of global iron ore usage, while iron ore accounts for around 90% of Rio’s earnings. Rio’s chief economist Vivek Tulpule recently forecast a steady decline in iron ore prices to just above $100 a metric ton by September 2014, largely due to excess capacity and falling demand in China. That is down from an average $126 last year.
At least Rio is prepared. Iron ore prices may continue to fall in the next few years, but exports look set to rise, keeping the miners profitable. Better still, the costly investment phase is now over, and we’re into the more rewarding production cycle. Many of my concerns are reflected in the share price, with Rio trading at 9.8 times earnings. You might find that tempting, alongside a 3.5% yield. Just keep your eye on the numbers that really matter with this stock, and they’re all coming out of China.