The shares of mining giant Rio Tinto (LSE: RIO) (NYSE: RIO.US), currently trading at 3,287p, have risen 50% over the last five years, modestly under-performing the FTSE 100, which has gained 58%.
However, Rio could deliver an even bigger rise over the next five years, because the shares have the potential to soar 88%.
Here’s how
It’s not so long ago that the financial pages — and, indeed, the wider media — were full of stories of China’s voracious appetite for natural resources, and the prospect of a mining supercycle.
However, with economic growth slowing in China and commodity prices at multi-year lows, ‘mining supercycle’ has disappeared from the popular lexicon, while industry commentators have been left asking: “Is the global mining supercycle over after only 10 years?”
Rio and the other big miners have shifted from massive investment — including acquisitions at inflated prices — to deploying capital in only the most promising projects, divesting non-core assets and cutting operating costs.
City experts see these measures helping Rio’s earnings per share (EPS) to advance from last year’s 335p to 395p by 2016. However, the analysts’ forecasts imply that there is then little further scope for cost savings, that oversupply in the iron ore market (Rio’s major market) will persist, and that the company will struggle to increase earnings — in fact, the consensus is for EPS of 387p by 2018.
All this adds up to an anaemic five-year EPS compound annual growth rate of less than 3%, and a total increase of just 15.5%.
If the shares track earnings, and continue to rate on their current trailing P/E of 9.8, the price will of course rise by the same 15.5% as EPS, putting Rio’s shares at 3,793p five years from now.
However, Rio is not alone among the mining companies in predicting strong longer-term demand for iron ore. Any sign of demand picking up five years from now, could see Rio re-rating to the FTSE 100’s long-term average historic P/E of 16. Such a re-rating, from the current lowly 9.8, would see the shares at 6,192p — an 88% rise from today’s 3,287p.
Investors would also bag five years of dividends. Analysts forecast a total of around 725p a share in paid out over the period — or £220 on a £1,000 investment.
There’s no guarantee that Rio’s shares will re-rate to the FTSE 100 average on indications of a cyclical (or supercyclical!) upswing — but, equally, they could re-rate even higher. In which case, investors could see a gain in excess of 88%!