Mining cash cow digs up a record profit and dividend payoutEmail...

Mining cash cow digs up a record profit and dividend payout
Email Print Normal font Large font February 26, 2006

SPOTLIGHT

Rio Tinto is riding high on the commodity boom, David Potts writes.

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AdvertisementWITH Rio Tinto voted one of the stocks most likely to hit $100 a share, it's not a question of whether but when to buy.

Mind you, the analysts' prediction that it could be the first stock to reach that $100 mark - the nearest rival, Perpetual, is neck and neck - has been delayed by the muted market response to its record profit and dividend payout.

The share price is still shy of its record $78.60, and is cheap if you look at the price-earnings ratio (P/E).

The P/E based on estimated earnings is about 14, which is low, making the shares underpriced compared with the market average of just over 15 and Rio Tinto's normal 21.

It's no surprise Rio Tinto has made a fortune from record prices and production of iron ore (the price rose 71.5 per cent last year) and copper (up 28 per cent).

Nobody knows when the commodity boom will end, but the money seems to be suggesting not for a while with analysts and economists talking about a "stronger for longer" cycle this time around.

Certainly it's different. As with BHP, Rio Tinto has become a dividend-paying cash cow. At this rate Rio Tinto will be debt free by next year. For a major resource company expanding production, that's unheard of.

Come to that, the major downside to its share price would be frittering away its cash flow on bad projects.

That seems unlikely since the company is being frugal with its dividend, so it can be maintained when the downturn eventually arrives. That's a new one for a resource company, too.

Mind you, it also paid out a juicy $US1.10 ($1.50) special dividend for which, strangely, it copped a blast from shareholders. (Sorry, we've passed the ex-dividend date.)

One thing to watch, however: while analysts are tipping a 20 per cent rise in iron ore prices from the latest round of negotiations, there are signs - such as BlueScope's disappointing result - that there's a glut of steel. And we know what iron ore is used for, don't we?

But then Rio Tinto digs up almost anything. It's in copper, diamonds, mineral sands and uranium as well.

And did I mention it produces alumina?

A more immediate problem is the rising cost of machinery, fuel and skilled labour, which it says it has under control.

ADVANTAGES

· Posted a record result, which will be even better this year.

· Paid a $US1.10 special dividend and plans a $US2.5 billion share buyback over the next two years.

· Experiencing record prices and output in its main products.

· Well-regarded, first-class management.

· Excellent track record of profitable expansion.

DISADVANTAGES

· Eventually commodity prices will drop and there are already signs of a steel glut.

· Mining costs are rising and there's a skilled labour shortage.

· Could yet squander its pile of cash on a bad acquisition.

· There's a currency risk if the US dollar drops.

· BHP is a cheaper point of entry to the resources boom.

VERDICT

Rio Tinto features at the top of nearly every expert's list of stocks to buy and, thanks to the commodities boom and its cashflow, there's little downside risk.