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Buy, sell or hold: Should you follow the managers back into Rio Tinto?

26 October 2013

In the next article in the series, FE Trustnet asks whether the Anglo-Australian miner represents a bargain and whether there are better options available in the same sector.

By Thomas McMahon,

News Editor, FE Trustnet

A number of fund managers have been moving in to the mining sector in the past few months, raising the question of whether private investors should be following suit.

The sector has done very poorly over the past three years as demand for commodities in China has slowed and the industry has found itself with a surplus of supply.

However, a number of high-profile managers have bought back into the sector. FE Alpha Manager Julie Dean began building up a position in Rio Tinto over the summer, while Standard Life’s Thomas Moore (pictured) told FE Trustnet last week that he has also built a position in the stock in his Standard Life UK Equity Income Unconstrained fund.ALT_TAG

The company is one of the most bought by fund managers over the past quarter, according to FE Analytics data.

Investors will need a strong stomach to do the same given the rocky ride the miners have experienced in recent years.

Data from FE Analytics shows that the FTSE 350 Mining index has lost 25.51 per cent over three years while the broader market has made 32.31 per cent.

Performance of indices over 3yrs

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Source: FE Analytics

Rio Tinto has lost 15.63 per cent in this time, while fellow miners BHP Billiton and Glencore have lost 13.27 per cent and 36.24 per cent, respectively.

Performance of stocks vs index over 3yrs

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Source: FE Analytics

However, the company posted generally positive results for the third quarter of this year on 15 October.


Iron ore production, which is responsible for the largest part of Rio’s earnings, grew 2 per cent, while copper production grew 23 per cent and aluminium rose 3 per cent. Coking coal production fell 6 per cent, however.

To put this into perspective, the company expects to produce 265 million tonnes of iron ore this year, compared with 43 million tonnes of aluminium and 590,000 tonnes of copper.

Shares continued their upward trend since June on the results – they have made an impressive 28.52 per cent in that time.

Julie Dean and the investors in the Cazenove UK Opps fund will be celebrating this success – but is it likely to continue?

Moore says the company now represents an interesting option for income investors.

Although its headline yield is not high, the manager says that Standard Life is one of several investors encouraging the company to return cash to shareholders, which bodes well for the prospect of dividend growth.

However, he is not convinced that the sector has turned the corner yet, making it a risky investment.

"We didn’t have any miners until early this year," he said. "The thinking behind the position was miners are closer to reaching that inflection point in their cycle where they have the revelation that actually they can direct their cash to shareholders."

"We are at the end of a 10-year cycle and capex [capital expenditure, investment in the business] must be reduced."

"Rio is the first to grapple with being too big. We apply pressure on companies to make changes and we have been in dialogue with Rio and similar stocks: capex is going to shrink."

"The bad news with mining companies is they are hugely dependent on commodity prices, so I would limit my exposure to those companies which have a great deal of conviction over management actions offsetting any weakness in commodity process."

Moore’s comments cut to the core of the debate around the miners. Investors first have to ask themselves where the cycle of demand and supply in the sector is.

The companies have suffered their re-rating thanks to a drop-off in demand from China and other emerging markets.

However, there are some signs that the corner may have been turned. China’s iron ore imports were at record levels in September (iron ore is Rio’s biggest product), up 8 per cent on August and 15 per cent year-on-year.

Copper imports hit their highest level since March 2012, while coking coal also jumped. This may well suggest that in the short-term the share price strength will continue – the company is trading on around 10 times earnings depending on the forecaster.

However, commodity prices are highly volatile and any disappointing data could well see prices fall. It is noticeable that managers are not prepared to stick their necks out and predict an imminent rebound in commodity prices, even if they think it worth the risk to drip-feed money into the sector.

The industry’s poor results have been exacerbated by management decisions: the companies have been widely criticised for over-expanding in the boom years and investing in over-capacity.

This means that they have been selling more into a market with less demand, pushing prices even lower.

There have been a number of high-profile management changes as a result of things turning sour.

Tom Albanese was removed as chief executive of Rio Tinto in January and replaced by Sam Walsh, who said he would be more disciplined in how he spends capital.

In the company’s recent results it announced it was on track to exceed its planned reduction in exploration and evaluation expenditure in 2013 of $750m.


Moore thinks the progress is encouraging, but The Share Centre’s Helal Miah (pictured) says that rival BHP Billiton has made more progress, and this could make it a better bet for private investors. ALT_TAG

"We like both companies and we have both on our buy-list, mainly because we see good value at the moment with longer term potential, especially if the Chinese economy isn’t as bad as feared," he said.

"The reason we prefer BHP Billiton is it’s more diversified. Rio is fairly concentrated and reliant on iron ore. If you look at the breakdown – it depends on where you look – it has between 50 and 60 per cent in iron ore, whereas BHP you are looking at around 30 per cent."

"It’s a more diversified business, the others are more into other metals and energy."

Rio Tinto’s strategy of focusing on its core business could exacerbate this problem, as it will leave it more exposed to the prices of certain commodities.

Miah points out that BHP Billiton's dividend is also superior to Rio Tinto's. The former was paying out roughly 4 per cent before its share price started to rise last week. Rio Tinto's yield is closer to 3 per cent.

Moore focuses on dividend growth in his fund, and Rio Tinto could be more attractive from that perspective, Miah agrees.

He says the management team has been slower to turn around its strategy, however. The company is still keen on expanding its iron ore production, which could be a liability if the market turns once again.

"Rio represents more risk because it’s still expanding its capex while the global economy is still weak, whereas BHP has said the market isn’t expanding so we won’t expand until we see an increase in demand. Rio Tinto managers are perhaps more gung-ho."

"They have both done big write-downs in the past year or so in terms of restructuring, but Rio Tinto probably made more mistakes in the first place."

Miah points to the 2007 acquisition of aluminium producer Alcan as a key mistake. The company has just launched a refinancing of the remaining loans from the acquisition.

"It depends on what you want as an investor," Miah concluded. "If you don’t have any commodities exposure, the first port of call is BHP, simply because it is the most spread out in terms of having more exposure to commodities. Then maybe look at a few other stocks like Rio Tinto and Glencore."

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