The latest results from Rio Tinto (LSE:RIO) revealed the Anglo-Australian mining company generated its highest profits in eight years.
Rio Tinto is one of the world’s leading mining companies. In the iron ore industry, in particular, it is a very big player. It’s also a well-run and highly profitable company. The dividend yield is currently paying out almost 6%. Furthermore, if you had invested in the company four years ago, the current dividend would represent nearly 12% of your investment.
I am not saying the company isn’t impressive, but I do have concerns relating to the company’s history and economic backdrop.
The history
Having the highest profits in eight years might sound good, but aren’t investors meant to be interested in the long run?
If so, then you would want to see profits steadily rising over time, not merely returning to the level seen near the beginning of the last decade.
Rio Tinto’s shares have doubled in value over the last four years, but still languish well below their all-time high. In fact, the share price would need to increase by more than a half just to equal the 2008 peak.
The economic backdrop
I wouldn’t be at all concerned if I thought that the current economic backdrop was positive, or if I thought that demand for iron ore was set to surge. Unfortunately, I don’t.
There is much we don’t know about the coronavirus, but I think it will continue to spread for some time.
I also fear that relations between the US and China could deteriorate further. Recently, Nouriel Roubini, the economist who predicted the 2008 crash more accurately than anyone, warned of challenging economic times ahead — largely emanating from China. The coronavirus will exacerbate this situation.
To this you can add concerns about the level of debt in China and the view that it has already ploughed too much money into infrastructure.
It would be an exaggeration to say that the iron ore market has been all about China in recent years, but it has been mostly about China. I don’t think Chinese demand for iron ore will rise like it has been doing.
Meanwhile, Rio Tinto remains too reliant on iron ore, where it has most of its business. It also has interests in copper and diamonds.
If Rio Tinto profits have only just returned to the level they were at eight years ago, after a period of rapid growth in spending by China, what will happen if those conditions reverse?
There is more than dividends
It’s the combination of a relatively disappointing record over the last 12 years and the likely economic weakness of China over the next few years that worries me.
If Rio Tinto can maintain its dividend, an investor might say “so what?”
The company is forecasting that steel demand will increase 2.5% a year, every year between now and 2030. If it is right, and this does happen, then Rio Tinto shares could be a good investment and dividends could rise further.
I just think we are more likely to see a slowdown.
It may be worth taking another look at Rio Tinto shares when we are through the worst of the coronavirus crisis, but for the time being I think there are better opportunities.