Rio Tinto (LSE: RIO) and Laura Ashley Holdings (LSE: ALY) are very different businesses, but each has earned a place on my buy list thanks to three very similar characteristics.
Quality advantage
Both Rio and Laura Ashley are above-average businesses that enjoy a competitive advantage, in my opinion.
Laura Ashley’s interim results, which were published on Wednesday, tend to confirm this. UK like-for-like retail sales rose by 7% compared to the same period last year, which is very good.
International sales are through franchised and licenced outlets, and profits are suffering because of Asian exchange rate factors. However, this doesn’t take away from Laura Ashley’s trailing operating margin of 8%, which is higher than Debenhams or Marks & Spencer, for example.
In Rio’s case, the firm’s ultra-low costs provide it with a strong competitive advantage. According to a recent presentation, the firm’s cash cost per tonne for producing iron ore has now dropped to $15.20. To put that in context, after extensive falls, iron ore is trading at around $55 per tonne.
Rio reported a group operating margin of 18% during the first half of the year. In my view, this business is almost guaranteed to remain one of the most dominant and profitable miners in the global market.
High yield
There’s no mistaking the appeal here. Rio offers a prospective yield of 6.1%, while Laura Ashley goes one better at 7.1%.
These aren’t unachievable payouts heading for a cut, either. Thanks to low costs and reductions in capital expenditure, Rio’s dividend seems likely to be covered by free cash flow and earnings per share this year.
Laura Ashley’s payout is only expected to be covered 1.25 times by earnings per share, but this company has a strong balance sheet and generates a lot of free cash flow.
Based on last year’s results and today’s interim results, I’d say that most, if not all, of Laura Ashley’s dividend is likely to be covered by free cash flow. When looking at the figures yourself, remember that the second half of the year (which includes Christmas) is typically much stronger than the first half.
The price is right
Even the best companies are only a buy if the price is right.
Rio currently trades on a forecast P/E of 14.5 for 2015, falling to about 14.0 in 2016. That’s not outstandingly cheap.
However, I think the valuation risk is offset by Rio’s high yield and strong competitive position. As one of the largest and lowest-cost iron ore producers in the world, this business will be one of the survivors in the sector.
At Laura Ashley, a forecast valuation of 11 times earnings looks reasonable. The Laura Ashley brand appears to be in strong demand at the moment in the UK and in Asia. Although no earnings per share growth is currently forecast for next year, I suspect this will change if exchange rate headwinds ease or if UK sales growth continues at the current rate.
I would be happy to buy shares in both Rio Tinto and Laura Ashley at today’s price.