The Rio Tinto (LSE: RIO) share price has had a stellar time this year, growing by more than 15% and outperforming many of its FTSE 100 peers. However, with talks of an impending global recession and economic headwinds, its stock may begin to stall.
Building momentum
As the world’s second largest iron ore producer, Rio Tinto sources iron for the world’s iron and steel industries. The production of steel is essential to maintaining a strong industrial base for construction, particularly buildings. It is for that reason that the Rio Tinto share price is heavily influenced by iron ore prices.
China is the world’s biggest consumer of steel by far, and consequently, is also the Rio’s biggest customer. As a matter of fact, the world’s biggest country contributes to more than half of the company’s sales.
| Consolidated Sales Revenue by Destination | Percentage | Sales Value (USD) |
|---|---|---|
| China | 57.2% | $36.3bn |
| USA | 12.6% | $8.0bn |
| Asia (Excluding China and Japan) | 9.4% | $6.0bn |
| Japan | 7.9% | $5.0bn |
| Europe (Excluding UK) | 5.2% | $3.3bn |
| Canada | 2.6% | $1.7bn |
| Australia | 1.8% | $1.1bn |
| UK | 0.4% | $243m |
| Other Countries | 2.9% | $1.9bn |
Due to the heavy reliance on China for its revenues, Rio Tinto has seen its share price fluctuate as China comes in and out of lockdowns. Due to the May lockdowns in Beijing and Shanghai, China’s last few Caixin Manufacturing PMI readings have come in below the desired rate of expansion. But with its government recently relaxing restrictions, Rio Tinto shares have rallied over 10% since. Nonetheless, an air of caution surrounds the stock as the uncertain landscape continues. The Chinese government is mass testing in Shanghai again, sparking fears of a new lockdown.
A recessionary top line?
Inflation continuing to run rampant across the world. Both the OECD and the World Bank published a set of gloomy forecasts earlier this week. The former expects global GDP growth to slow sharply this year at 3%, and remain at a similar pace in 2023.
When coupled with China’s zero-Covid policy, the war has set the global economy on a course of slower growth and rising inflation — a situation not seen since the 1970s.
Source: OECD Economic Outlook
The World Bank also expects emerging markets such as China to get hit the most, downgrading growth in emerging markets to 3.4%. Based on these forecasts, I expect the growth in Rio Tinto shares to start tapering off.
A strong core?
Nevertheless, Rio Tinto does have a decent balance sheet to weather a potential global recession. For starters, it has a healthy debt-to-equity ratio of 21.5%. Additionally, it has enough cash and equivalents to cover its current debt. The FTSE 100 firm also boasts an excellent profit margin of over 33% in FY 2021! That being said, its short-term assets do not cover its long-term liabilities. Therefore, if a massive slowdown in free cash flow were to occur, Rio Tinto may struggle to pay off its long-term debt.
Although earnings are expected to decline as a result of a global economic slowdown, things could also very quickly turn around if China abandons its zero-Covid policy. Rio’s reasonable price-to-earnings (P/E) ratio makes the stock a lucrative one for me. But most importantly, its excellent dividend yield of 10% makes it an income stock for me to hold. So, while I expect the Rio Tinto share price to stall, I’ll be buying shares on the dip to generate some passive income over the long-term.