Global mining company Rio Tinto (LSE: RIO) (NYSE: RIO. US) has just signed an Investment Framework agreement in conjunction with its partners with an eye to developing the largest combined iron ore mine and infrastructure project ever developed in Africa.
Located in Guinea, the plan is for a high-grade iron ore mine capable of producing 100 million tons per year, a new 650km trans-Guinean multi-user railway to transport iron ore to the Guinean coast, and a new deep-water multi-user port in the Forécariah prefecture. Sounds exciting, and the agreement aims to leave Rio with an almost 47% share.
Investing for the future
Setting out initial terms of agreement between partners is a necessary early step, but cash inflows to Rio from the project will still be a long way off. First, Rio must invest in the development, and thinking ahead like that in the world of commodities is fraught with uncertainty. The firm’s financial performance took a dive when high commodity prices in recent years started to fall and high input costs, which had risen in the boom years, squeezed out much of the firm’s profit.
Economic cyclicality drives the resources sector and causes output commodity prices to rise and fall. Rio’s recent strategy has involved bearing down on costs and reforming the culture within its organisation. There’s also been a push to increase production levels and the appointment of new, highly incentivised, top management. Initiatives such as the proposals for Guinea seem to indicate the directors must feel confident that Rio’s recovery from the trading lows of recent years has enough traction to support major investment opportunities.
Valuation
At a share price of 3,235p, Rio trades on a forward P/E rating of about nine for 2015. The forward dividend yield is running at about 4.1% with city analysts expecting forward earnings to cover the payout about 2.7 times.
That looks like a fair price, but it seems unclear whether future cash flow growth will be enough to overcome the inherent cyclicality of the industry to drive up the share price. However, initiatives like the potential project in Guinea seem encouraging.