Rio Tinto shares – from bombed out to fair value

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Rio Tinto shares – from bombed out to fair value

Rio Tinto (RIO) shares have come from being bombed out earlier this year to fair value. Any fragmenting of confidence in world economic recovery triggered by Brexit will surely depress the shares again?

The time has come to have another butchers at Rio Tinto (Rio) after what Japanese pilots used to call a “Heavenly Wind” attack; I refer of course to the ‘Brexit’ dive bomb vote. Looking for reassurance, I read Boris’s article in Monday’s Telegraph in which he concludes that the rise of the FTSE 100 Index is evidence of his earlier “Project Fear” assertions and not the significant fall in the exchange value of the pound against the dollar. I do worry about the lack of market knowledge in our political leaders! He should have been looking at the FTSE250 Index containing UK domestic stocks, which tells a different tale. He does not seem to think that the fall in sterling against the dollar was evidence of well informed of international market concern about the UK leaving the biggest and economically wealthiest trading bloc on the Globe.

Anyway, the Rio Tinto share price has done well in the last week as its international profits and earnings benefited from the accounting translation effect of rendering strong dollar related profits into a weakened pound sterling. That has been a surprising cherry on the cake of a good share price trading period for Rio Tinto or RTZ as it long been known.

There are no recent results to consider, so this is an exercise in looking at the share in terms of its latest price and its valuation in relation to the most recent accounting figures and earnings estimates that we have.

On the eve of the referendum vote, the share price had slipped a bit, no doubt in rational anticipation of a ‘Remain’ vote, to somewhere just above 1900p. The share price since then has risen about 21 percent to 2356p, on subsequent sterling weakness. With arithmetic neatness, the dollar /pound exchange rate has fallen by about the same percentage rate from 1.50 dollars to the pound to 1.33 dollars to the pound. So the currency and share price movements have initially synchronised very closely, reflecting the limited, strictly accounting translation implications of the Brexit vote. Here, the equity market is following the currency market like a shadow.

Where now……?

So do RTZ shares look a buy, sell or just a hold? I last wrote about Rio shares way back in February when they were priced at 1705p – after publication of the annual figures for the year to December 31st 2015. The final dividend was maintained but a more pragmatic earnings related dividend policy – with a minimum dividend guarantee – came in, putting a floor under the share price. I judged the shares as looking lowly valued and therefore attractive on that basis, for investors looking for long term value at knock down prices. Thus, the share even before the Brexit vote had risen by some 11 percent on the assumption that the British people would, risk aversely, vote to remain inside the safety and advantage of the world’s biggest trading bloc in light of expert advice from the world trade organisation and almost every professionally qualified body in sight, including the Institute of Fiscal Studies and as well as George Soros himself.

What a share like Rio Tinto Zinc requires at this stage, is a continuation of the world recovery. An event like Brexit, which has implications for EU and the massive EU currency as a significant store of value and means of international exchange, also imparts a secondary shock, to the EU and thus onwards to the world’s economic prospects as well as those of the UK. That now needs to be taken into consideration when attempting to evaluate the prospects of mining shares. The problem is how to evaluate such a risk, without points of reference in the unique situation now confronting us? The simple fact is that we cannot know the answer until enough time has elapsed to produce the facts and trends revealing the truth of it.

However, we do know that there was already growing concerns about the strength and resilience of the coming stage in the US economy, the world’s largest; and that Brexit and its implication for the EU and the Euro, will not have helped the fragility of that economic progress.

Meanwhile, the shares for much of the last year have been in a perceived, approximate trading range of between 1600p to 2500p .The share price at 2364p now seems to be well its way towards that previous high which it will reach with another increase in the share price of five percent or so.

Looking at the most recent consensus estimates of Rio’s prospects this year and next, they include a 37 percent in estimated earnings this year; that would seem to reflect a tougher year for earnings in real terms. Although, the big fall in sterling will have done much to reduce that when looked at through the eyes of a pound sterling shareholder, dollar based investors will better detect the weakness in dollar terms.

The estimated sterling annual dividend, presumably forecast on the basis of a $1.5/£1.0, is 3.1 percent for this year, is 3.5 % for this year and 3.0% next year.

I think it safe to say that if the markets get a sniff of further deterioration in the world’s economy, then RTZ shares will head south again after a strong rally since the beginning of the year when they were bombed out.

For the time being, the share price momentum is carrying the share price forward. The estimated dividend yield of 3.5 percent for this year looks useful but dividend payments according to the consensus estimates show an expectation of a dividend cut next year bringing the annual dividend down to 3.1 percent next year as Rio puts more money into its big copper project.

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