Rio Tinto (RIO, Financial), a global mining major, is a good stock to buy and hold for the medium to long-term. This article discusses the investment positives for this value stock.
Diversified Revenue By Region
For 2013, Rio Tinto reported sales of $54.6 billion. The biggest positive factor in the results was the revenue mix by region. In general, commodity companies have a high reliance on China and have been meaningfully impact by the slowdown in the region.
For Rio Tinto, only 35% of 2013 revenues have come from China with Japan and other Asia contributing to 31% of the revenue. While China is the single biggest revenue contributor for the company, the revenue reliance on China is not too high. Another positive is that growth in China might have bottomed out in all probability.
I however believe that other Asia (excluding Japan) will be the next big revenue generator for Rio Tinto. For 2013, other Asia contributed to 15% of the revenue. This is likely to trend higher over the next few years with incremental GDP growth in India. The country can potentially be as big a commodity market as China.
Overall, diversified revenue reduces the revenue volatility risk for Rio Tinto and serves as one of the key positives.
Non-Core Asset Disposals
Rio Tinto has also embarked on a strategy to dispose non-core assets since 2008 and the strategy has worked for the company in terms of increasing the financial flexibility to invest in core assets. Since 2008, the company has made 20 divestments worth $17.1 billion. The divestments in 2013 generated cash proceeds of $2.5 billion and the one divestment in 2014 has generates cash proceeds of $1.0 billion.
As the company generates cash from asset sales, the proceeds are being used to dispose debt and invest in core-assets. The company’s net debt has declined from $22.1 billion in June 2013 to $18.1 billion in December 2013.
Further, the company expects to incur nearly $20 billion in capital expenditure over the next two years. This will translate into increased revenue and cash flow in the future from core projects.
Cost Reduction And Shareholder Value Creation
In 2013, Rio Tinto reduced operating cost by $2.3 billion and the company intends further cost reduction of $3 billion in 2014. The cost reduction initiatives are likely to increase the company’s EBITDA margin and also boost shareholder returns.
Rio Tinto has increased shareholder dividend payout by 34%, 15% and 15% in the last three years. In 2014, the company has further increased the target dividend payout by 15%. I believe that the increase in dividend will continue with an improving global GDP outlook.
The stock already looks attractive at a dividend yield of 4.2% at a current stock price of $52.6. I don’t foresee any share repurchase program by the company. However, dividends will continue to swell, making Rio Tinto a good dividend stock to hold.
Also supporting the company’s increasing dividend payout is the operating cash flow position. As of December 2013, Rio Tinto generated an operating cash flow of $20 billion and incurred a capital expenditure of $12.9 billion, resulting in free cash flow of $7.1 billion. The cash flows are strong enough to support the ongoing expansions coupled with a high dividend payout.
Risk Factors
As mentioned earlier, China contributes to 35% of the company’s sales. While the sales profile is diversified, China’s contribution is still meaningful. China’s economy might be on a recovery path. However, it is too early to conclude that the recovery will be sustainable. Any renewed decline in GDP growth will impact Rio Tinto’s growth plans and likely cash generation.
Rio Tinto is also exposed to high volatility in commodity prices. This is especially true in the current scenario where interest rates are near zero levels in the developed world. Low interest rates increase asset price volatility through increased speculation across asset classes.
Conclusion
Rio Tinto has survived the most difficult phase in the global economy and its growth. The company now has a focused strategy and is selling non-core assets in line with this strategy. Reduced debt, higher returns to shareholders through dividends and a strong investment pipeline for core projects bodes well for the shareholders and for value creation. The stock is an attractive buy at a current EV/EBITDA of 6.2 and a robust dividend yield of 4.2%.
