Today I am looking at two numbers that make me believe Rio Tinto (LSE: RIO) (NYSE: RIO.US) is a high-risk share pick.
80
The iron ore market is a big deal for diversified miner Rio Tinto, as the commodity is responsible for approximately three-quarters of group earnings. So concerns that the resource’s supply/demand balance continues to deteriorate should come as huge concern to the business.
Indeed, Bank of America-Merrill Lynch this week guillotined its forecasts for the next few years. It expects an average iron ore price of $99.6 per tonne — already down from $107 previously — to fall to $80 per tonne in 2015 and 2016, down from a former forecast of $95. And the broker noted that prices could even fall as low as $60 during the latter half of next year.
Bank of America noted that “iron ore has reached the shake-out stage, i.e. for the market to rebalance, prices need to be low enough for producers to shutter operations.”
But it does not expect these steps to transpire any time soon, commenting that “a massive wave of new supply coming on stream (200 million tonnes in 2015 and 2016), coupled with high inventories in the system, should continue to weigh on prices in the next couple of years at least.”
Rio Tinto announced last week that iron ore shipments hit a record quarterly high of 78 million tonnes during July-September. At face value this is good news, with sales rising 15% from the corresponding 2013 period. But this improvement was up just 3% from the prior three months, fanning concerns of slowing demand for the steelmaking ingredient.
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Given this environment of worsening fundamentals across key commodity markets, City brokers expect Rio Tinto to record a chunky 8% earnings decline during the current 12-month period, down to 505.4 US cents per share. A modest 2% improvement is pencilled in for 2015, to 514 cents.
Optimists will point to the firm’s massive asset and expense-slashing drive as critical to the firm returning to growth beyond this year. Indeed, chief executive Sam Walsh noted this week that “our strategy of focussing on long-life, low-cost assets means we will continue to generate strong cash flows despite a lower price environment.”
But of course this forecast depends on just how far commodity prices fall. Given the steady stream of global economic downgrades doing the rounds in recent weeks, a period of sustained pressure on revenues — and consequently earnings — is a very real possibility.