We live in strange times. Even though geopolitical uncertainties are high, due to many central banks’ easing, stock indices are near record highs, whereas some experts say that there is an asset bubble.
Yet, this rally did in no way affect natural resources companies. Among them is Rio Tinto (LSE:RIO), a company specialising in finding, mining and processing iron ore, aluminium, copper, diamonds, minerals and energy. I would like to explain the reasons for Rio’s cheapness as well as the merits of its stock.
Coronavirus
The quarantine in China has direct and indirect effects on companies like Rio Tinto. First of all, the miner is facing a slowdown in copper shipments from Mongolia to China because of the transportation restrictions imposed as part of the Chinese government’s efforts to contain the coronavirus outbreak. The same is true for other metals, including iron ore.
Not only are many overseas producers prohibited from shipping metals and minerals to China, even deliveries within China are not allowed. Thus, most companies requiring iron ore and other metals for their production process are unable to receive them.
Secondly, many companies operating in China are forced to temporarily shut the factories. It is especially true for car manufacturers, capital equipment producers and technological companies. Therefore, there is a clear decrease in demand for metals in China.
Nevertheless, in my view the effect of the tragic coronavirus outbreak on the economy would only be temporary.
Manufacturing downturn
The price of metals, including iron ore, aluminium and copper, are near 52-week lows.
This is not only the result of the coronavirus outbreak but also of an overall downturn in the manufacturing sector, which mainly concerns Germany and China. The downturn in the manufacturing was mostly due to geopolitical uncertainties such as trade wars.
However, many experts believe that due to the US-China Phase-1 trade deal, fiscal and monetary stimulus measures taken by the governments, investors’ interest should increase.
Investment merits
First of all, Rio Tinto is a large and well-established company with a history of about 150 years of operations. Its mean average price-to-earnings ratio across 2016-2018 was approximately 12, whereas for 2018 alone it was about 6.
Rio has a decent history of paying dividends, with its current dividend yield exceeding 6%. The earnings have been growing since 2016, even though in 2015 Rio reported a small deficit.
The only matter that might raise questions is its price-to-book (P/B) ratio, which is 1.36, whereas the current ratio is 1.91. Many investors would prefer to see a P/B ratio of 1 or below. The current ratio is almost 2, which is in line with expectations, since a figure between 1.5 to 3 is considered acceptable.
Short-term investors might also benefit from buying Rio’s shares ahead of its earnings report because according to many analysts’ estimates, profits increased in 2019. This was due to a dramatic decrease in iron ore production, experienced by Vale, the main competitor of Rio Tinto.
However, I would suggest buying and holding Rio to those long-term investors that believe that the manufacturing downturn will end quite soon.