Why I've Bought Rio Tinto

Published in Company Comment on 10 October 2012

A Fool looks at the big five mining and commodity shares in the FTSE 100.

Trying to predict the future is a mug's game, but despite this, I'm pretty certain that the global economy will still need large amounts of iron ore and copper in several decades' time.

That's one of the reasons why I recently added shares in Rio Tinto (LSE: RIO) to my retirement portfolio. This is a company I tipped back in June as a great buying opportunity and which currently offers a dividend yield of 3.0% -- below the FTSE 100 (UKX) average, but quite respectable for a miner.

Income focus

As I've written before, the investment philosophy behind my retirement portfolio is based on balanced, long-term investment in the main sectors of the global economy. Barring a global economic meltdown, I hope that this approach will provide a decent dividend income for me when I eventually retire.

Why Rio?

Of course, Rio isn't the only big miner in the FTSE 100. The most obvious alternative is BHP Billiton (LSE: BLT), another Australian-based diversified miner with a £40bn+ market capitalisation and a big business in iron ore.

I don't pretend to have the expertise necessary to independently value each of these businesses and forecast their earnings, but I do know what I want and I chose Rio for three main reasons:

  1. It's cheaper. Rio currently trades on a price-to-earnings ratio of 6.0, compared to 9.6 for BHP Billiton. Over the long term, I expect this discount to even out.
  2. Copper: Rio is in the final stages of opening a large new copper mine in Mongolia. This is expected to contribute to a 13% annual rise in earnings from the red metal between now and 2015. I see copper as a good diversifier to help reduce Rio's dependence on iron ore, from which it currently gets around 80% of its earnings.
  3. 23% of BHP's earnings came from its petroleum business in 2012. As I already own shares in Royal Dutch Shell, I didn't want any more oil exposure.

An alternative idea

Given my goal of gaining an income stream from the global commodities market, I did identify another attractive possibility that you might want to consider.

If it succeeds, the proposed merger between Xstrata (LSE: XTA) and Glencore International (LSE: GLEN) will create the biggest mining and commodities company in the FTSE 100. 'Glenstrata' would have a market value of £53bn and could be an attractive long-term investment, as both companies are currently valued quite modestly.

Although mergers are always a risk, Glencore already owns 20% of Xstrata and the two companies look like they should be a good fit. The uncertainty over the deal has driven down the share prices of both companies over the last month and Glencore's shares are down by more than 8% -- so now could be a good time to buy, as the price could rebound once the uncertainty abates.

Not my choice

The FTSE's mining sector is home to five companies with market values greater than £20bn. Of these, the only one I haven't mentioned so far is Anglo American (LSE: AAL), whose share price has dropped by more than 23% so far this year, making it by far the worst performer of the five.

Many of Anglo's operations are in South Africa and this is causing problems at the moment. Anglo American Platinum sacked 12,000 miners (20% of the workforce) at its Rustenburg platinum mine on Friday, following their refusal to return to work after an illegal strike or attend disciplinary hearings.

The company's Kumba iron ore mine is also being affected by strike action and falling commodity prices have hit Anglo hard this year. However, you could argue that much of the bad news has already been factored into the company's share price, making it a possible contrarian buy.

Mining a recovery?

Mining shares tend to be quite volatile and are extremely cyclical. The last thing you want to do is to buy these shares at the top of a cycle, when yields are low and prices are high.

To help you avoid this risk, I would strongly recommend you take a look at "Top Sectors for 2012", a free report from the Fool that identifies two mining shares that look set to perform very well over the next 12 months.

In the report, the Fool's expert analysts explain why they expect these two mining shares to deliver strong returns -- and identify two alternative high-quality shares that provide an excellent opportunity to capture ongoing growth and income.

Download the report now while it's still available -- it's completely free and without obligation but, like all the Fool's free reports, availability is strictly limited.

Are you looking to profit from this uncertain economy? "10 Steps To Making A Million In The Market" is the very latest Motley Fool guide to help Britain invest. Better. We urge you to read the report today -- it's free.

Further investment opportunities:

> Roland owns shares in Royal Dutch Shell and Rio Tinto, but does not own any of the other shares mentioned in this article.

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Comments

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atalbot9 10 Oct 2012 , 11:19am

A friend has asked me to set up a £50k portfolio for him, with a 5 year view, moderate risk. He already owns a UK property. Based on my investing experience of the last 5 years and where I would feel comfortable putting my money, this is my initial suggestion. Comments appreciated!

For yield (use income to top up attractive positions over 5 years, i.e. not reinvest dividends):
£5k - RSA (insurance)
£5k - RUSP (logistics)
£5k - SLXX (corporate bond ETF)

For yield and growth (same view on income as above):
£5k - RIO (mining - base)
£5k - BBY (infrastructure / construction)
£5k - PNN (utilities)

For growth:
£5k - PDL (mining - diamonds)
£5k - GKO (renewable energy - India)
£5k - GBO (tech)

For insurance / inflation hedge / etc:
£5k - SGLN (gold bullion ETF)

I am invested in most of these myself and know each firm fairly well. any suggestions in the "yield and growth" category would be particularly welcomed. I know pref shares are controversial, but RUSP has been very good to me and company is well-positioned for the future.

Thanks - GLA

ANuvver 10 Oct 2012 , 3:22pm

atalbot9:

Looks reasonable. I'd want to add something based on strong-brand global consumer goods, but I appreciate those aren't generally cheap right now.

I'm a fan of SLXX, but there are murmurings of increasing liquidity risk in the bond space at the mo. There is a non-financials version (ISXF) available, with a higher distribution. Hannibalis might have something to say on the subject, or you could check out his website.

The much-recommended 10% gold allocation I note.

I'm not an expert on ETCs, and I'm no gold bug but I would suggest physical holding as a better alternative. £5K would currently get you something like 17 bullion sovereigns ("bullion" in this context denotes coins with no numismatic value, which are traded for gold content alone - anything fancier, prettier or rarer and you'd have to become a collector/dealer). Sovereigns are not CGTable, since they are legal tender. The only issue would be keeping your mouth shut that there's a treasure hunt available in your house...

vinchainsaw 10 Oct 2012 , 3:55pm

I've never understood the physical owning of gold mantra that many seem to espouse, as opposed to buying a gold-backed ETF or the like. Could somebody help with an explanation?

As I understand it a gold ETF like SPDR is backed by physical gold anyway? Only you don't need to haggle over the price, don't need to store it and don't need to insure it?

If the markets go for a ball of £$%^ then surely the world as we know it would be pretty much ended anyway? What good will your lump of yellow gold do for you then, whether you hold it in a vault somewhere or under your bed? You'd surely be better off then with a Smith & Wesson? I certainly wouldn't be trading my S&W for your lump of metal.


vinchainsaw 10 Oct 2012 , 3:56pm

Not trying to denigrate gold, just curious as to why some people think its needs to be a physical gold holding?

goodlifer 10 Oct 2012 , 5:57pm

Hi atalbot9,

I'd be inclined to bet you'll make your friend money on your first two packages, but lose it for him on the other two.
Unless of course you're either very lucky or very much more gifted foresight-wise than I am.

As for gold, it's never worth buying except possibly when the Gordon Browns of this world are selling.

ANuvver 10 Oct 2012 , 6:13pm

All sort of risks attach to a paper promise of an asset rather than the asset itself. Given that an investment in gold is largely a hedge against worsening sentiment on paper assets, why buy a paper version of gold when you can own it direct? Concerns include leverage, adulteration, accountability, custodianship arrangements, confiscation, management fees.

But the best advantage for physical gold is CGT exemption on sovereigns, Britannias and the like.

As I said, I'm no gold bug, but if you're going down that route, physical has many attractions.

BigJC1 11 Oct 2012 , 12:41pm

atalbot9; I'd probably add HSBC, reasonable yield, good growth prospects (up 15% this year), strong brand and great global reach.

mao44 11 Oct 2012 , 3:55pm

I would go for CLN rather than BBY for the higher yield.

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